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Master Thesis in Management November 22, 2012
Master of Science in Business and Economics
Stockholm School of Economics
Elaboration of a Franchising Strategy
- The Strategy Behind the Choice of a Franchising Agreement -
Alexandre Mignault
- 40070 -
Abstract
While substantial research has taken place on the antecedents of franchising, very little research
has looked at the finer details of how franchising actually takes place. The aim of this thesis is to bridge this gap by identifying the types of franchising agreements that are used and the factors
that lead to the choice of a specific franchising agreement by a franchisor. I found that the companies studied did not restrict themselves to the usual franchising agreements, instead
choosing to tailor these agreements to their situation. Franchising agreements that are
traditionally used mostly look at the size of the franchise and at the rights of the franchisee. This study found that companies customize franchising agreements by also considering the role they
will play in the financing of the franchise. The interviewees helped identify a certain number of factors that had an impact on whether an outlet would be company-owned or franchised, as well
as on the type of franchising agreement used. I found that the factors that affected the two
companies' decisions were closely linked to the three main theories on the antecedents of franchising (resource scarcity, agency theory and plural form). However, there were slight
difference in terms of the factors considered by the two companies. Although this thesis did not try to compare the two companies, my hypothesis is that the differences in terms of factors
affecting the type of franchising agreement chosen came from the different stages of the business cycle at which the two companies were.
Keywords: Franchising, Franchising Agreements, Company Ownership, Organizational Form
Presented in: December 2012
Supervisor: Ingela Sölvell
Researcher at Center for Advanced Studies in Leadership
Stockholm School of Economics
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Table of Contents
Introduction ............................................................................................................ 4
Background ......................................................................................................... 5
Problem ............................................................................................................... 7
Purpose ............................................................................................................... 7
Research Question ............................................................................................... 9
Research Objects ............................................................................................... 10
Delimitations and Limitations ............................................................................... 11
Thesis Structure ................................................................................................. 12
Theory .................................................................................................................. 13
Literature Review ............................................................................................... 13
Resource Scarcity Theory .................................................................................... 14
Push-Pull Model .............................................................................................. 15
Life-Cycle Model .............................................................................................. 16
Predictions made by Resource Scarcity Theory and Recent Insights ..................... 18
Agency Theory ................................................................................................... 20
Two Streams: Positivist Agency Theory and Principal-Agent Research .................. 21
Agency Cost ................................................................................................... 22
The Plural Form in Franchising............................................................................. 23
Gaps in Previous Research .................................................................................. 24
Research Methodology ........................................................................................... 26
Research Method ............................................................................................... 26
Research Design ................................................................................................ 27
Choice of a Research Object ................................................................................ 28
Qualitative Approach ....................................................................................... 31
Data Collection ............................................................................................... 31
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Research Approach ......................................................................................... 35
Validity and Reliability ...................................................................................... 36
Empirical Findings .................................................................................................. 39
Source and Handling of the Data ......................................................................... 39
Franchising Strategies ......................................................................................... 40
FoodChain Franchising Strategy ........................................................................ 40
Art4Everyone Franchising Strategy ................................................................... 49
Analysis and Discussion .......................................................................................... 53
Analysis and Discussion ...................................................................................... 54
Types of Franchising Agreements ..................................................................... 54
Factors that Affect the Organizational Form of the Outlet ................................... 56
Conclusion ............................................................................................................ 70
Answer to The Research Question ....................................................................... 71
Franchising Agreements Used by Companies ..................................................... 71
Factors that Affect the Franchising Agreement Used ........................................... 72
Limitations, Generalizability and Managerial Implications ....................................... 75
Future Research ................................................................................................. 76
Additional Exploratory Research ....................................................................... 76
Bibliography .......................................................................................................... 78
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Introduction
While McDonald's is perhaps the best known franchisor in the world, some will be
surprised to know that McDonald's is not the inventor of franchising. Indeed, it is
actually Isaac M. Singer who usually gets the credit for the modern use of franchising in
the United States (Bannister, 2012). Singer had improved an existing sewing machine
and wanted a wider distribution for his product but lacked the money to increase
manufacturing. People also wouldn't buy machines without training, which retailers were
not able to provide. His solution was to charge licensing fees to people who would have
the right to sell his machines in certain areas and provide training (FranChoice, History
of Franchising).
According to a report published in 2005 by the International Franchise Association, the
impact of franchised firms on the United States' economy totals $2.31 trillion per year,
which represents approximately 11.4% of the private sector (Combs et al, 2011).
Indeed, franchising has enjoyed tremendous popularity in the United States, especially
in the quick service restaurant industry. According to a report published by the
International Franchise Association in 2007, franchised quick service restaurants have
accounted for 68.5% of all jobs in the quick service restaurant line of business
(PriceWaterhouseCooper, 2008).
McDonald's, Subway, Pizza Hut and Taco Bell are all good examples of multinational
corporations that used franchising as a way to grow their business. The story of how
McDonald's used franchising to grow its business is particularly telling. The story begins
in 1954 with a milk shake maker salesman called Ray Kroc. Kroc had received a huge
order for 8 multi-mixers from a small restaurant in San Bernardino, California called
McDonald's. Surprised to see one restaurant order so many milk shake makers, Kroc
decided to investigate. He found a small but successful restaurant run by brothers Dick
and Mac McDonald and was stunned by the effectiveness of their operation. Kroc had
never seen so many people served so quickly. He was so impressed with the business
concept that he decided then and there that his future would be in hamburgers. He
learned that the McDonald's brothers had been looking for a nationwide franchising
agent. Inspired, he pitched the idea of opening several restaurants and they accepted
(McDonald's, 2009).
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A year later, Kroc founded the McDonald's Corporation and opened his first restaurant in
Des Plaines, Illinois. In 1965, McDonald's already numbered 700 restaurants. By 1988,
that number had grown to more than 10 000 restaurants (McDonald's, 2011). Today,
there are more than 33,000 restaurants worldwide, employing 1.7 million people and
serving 68 million people in 119 countries every day. Nearly 80% of those restaurants
are franchised (McDonald's 2012). This story shows that franchising can be a very
effective way to grow a business.
Background
Franchising is a business arrangement under which a firm (the franchisor) collects up-
front and on-going fees in exchange for allowing other firms (the franchisees) to use its
processes and offer its products and services under its brand name (Combs et al, 2011).
The resource scarcity theory posits that this sort of business arrangement is interesting
for the franchisor because he gets the opportunity to build his organization quickly as
new outlets are funded and managed by franchisees. This is an important advantage for
new firms as they often lack capital and have a hard time competing for skilled labor
(Combs et al, 2004). Fast growth gives the franchisor access to economies of scale in
purchasing and marketing which ultimately enhances his likelihood of success. Agency
theory, on the other hand, posits that firms use franchising because it reduces their
monitoring costs. Franchisees have stronger incentives than managers therefore they
need less monitoring. After all, a franchisee's income is directly tied to his efforts in
improving the store's performance (Combs and Ketchen, 2003). On the other hand, the
incentives to over-perform are not as strong for a manager because the additional
profits go to the franchisor.
As for the franchisee, he gets the opportunity to own his own business under the
umbrella of a tested business concept which is already known to customers (Combs et
al, 2011). The franchisee is more likely to succeed in his endeavor because customers
already know and trust the brand, therefore they are more likely to go to that store
rather than to competing stores that have yet to make an impression with them. This
phenomenon is partly due to a concept in psychology called loss aversion which refers
to the fact that people prefer avoiding losses to acquiring gains. Applying this concept to
restaurants, customers generally prefer eating at a restaurant whose food they know
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they enjoy rather than taking a chance on a new business whose food might not be as
good. The franchisee also benefits from the economies of scale in purchasing generated
by the organization.
Franchising clearly presents huge advantages for both the franchisor and the franchisee
therefore it is no wonder that it has enjoyed such popularity. It should be noted that the
concept of franchising has evolved quite a bit over the past few decades and there are
now several types of franchising agreements from which companies can choose once
they have made the decision to franchise. Four types of franchising agreements are
generally mentioned in research and by franchising associations. Brief descriptions of
these types of franchising agreements can be found in the table below.
Table #1: Description of the Various Types of Franchising Agreements
(FranStop, Types of Franchise Agreements)
The most common type of franchising agreement is the single-unit franchise. According
to FranData research, more than 4 franchisees out of 5 (82%) are single-unit operators
(Johnson, 2007). Single-unit franchisees control 51% of all franchised units. Single-unit
franchising is typically the way most franchisees enter the world of franchising. It gives
Franchising Agreement Description
Single-Unit Franchisee Franchisee may operate one franchise. Franchisee may have a
small radius of exclusive territory to operate within.
Multi-Unit Franchisee Franchisee may operate more than one outlet. There is usually no
exclusive territory where the franchises must be opened.
Area Development Licenses
Area development licenses grant the franchisee the right to open a
certain number of franchises within a given area. The franchisee
has exclusive rights to this area as long as he opens the agreed
upon number of outlets during the agreed upon time period.
Master Franchises
Master franchises grant the right to open a certain number of
franchises within a given area. The master franchisee also has the
right to sell franchises, multi-unit franchises and area development
licenses. He has exclusive rights to this area as long as he opens
the agreed upon number of outlets during the agreed upon time
period. He also receives a part of the ongoing royalties paid by
each franchisee.
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the franchisee a chance to understand the franchising system while also giving the
company the opportunity to evaluate his performance and see whether he is ready for
additional franchises. Another 15% of all franchisees own between 2 and 5 units,
controlling 24% of all franchised units, and finally 3% of all franchisees own more than
5 units, controlling 24% of all franchised units.
Problem
Once a firm has chosen to add new stores, there are still many decisions that have to be
made. Should the store be company-owned or should it be franchised? Which
franchising agreement should be used? Are there lesser known types of franchising
agreements to consider? Under what circumstances should these franchising
agreements be used? These are all important questions for the franchisor yet very little
research has been conducted on the subject. It would be useful for franchisors to have a
better understanding of the various types of franchising agreements that exist as well as
understand what factors lead to those types of franchising agreements being used by
companies today.
Purpose
The purpose of this thesis is to add knowledge to the research field of franchising by
making explicit the experiences of two widely different companies when they have to
decide on the type of franchising agreement they will use when adding new stores. To
do so, I will give an overview of the various franchising agreements that these
companies use and explain what factors lead them to choose one over the other.
In order to understand under why certain factors lead to specific franchising agreements
being chosen, I will draw from three theoretical perspectives, two in particular. The two
main theories that this thesis will draw from are agency theory and resource scarcity
theory. To a lesser extent, the plural form in franchising is also going to be used. I have
chosen to use these three theoretical perspectives because they are complementary and
only using one theory would have led to a weaker analysis. None of the three theories
"is able to explain the full franchising occurrence, but each theory explains different
parts of the franchising phenomenon, so they should be perceived as complementary
theories" (Diaz-Bernando, 2012). Similarly, Eisenhardt (1989) recommended that agency
theory be used with complementary theories, as "agency theory presents a partial view
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of the world that, although it is valid, also ignores a good bit of the complexity of
organizations. Additional perspectives can help capture the greater complexity". Hence,
all three theoretical perspectives are going to be outlined in my theoretical framework.
This thesis' main contribution will be to enhance knowledge as to what factors
companies consider when deciding which franchising agreement to use, as well as how
each factor affects the decision. Seeing as two companies are going to be studied, the
end result is going to be a list of factors that affect the companies' decision to franchise
or own an outlet, a framework that shows which conditions must be met for the
companies to choose franchising instead of company-ownership, as well as subsequent
frameworks that show how each factor affects the type of franchising agreement
chosen.
I chose to include company ownership in the framework of this thesis because company
ownership is always an option which is studied alongside the various franchising
agreements. After all, franchisors often have "first right of refusal", meaning that if the
franchisee wishes to sell his franchise he must offer it to the franchisor before selling it
to someone else. Additionally, few chains completely stop having company-owned stores
even if they have chosen to use franchising as their main growth strategy. Looking at
the table below, it seems that out of fifteen major quick service chains, thirteen chains
increased their proportion of franchised stores but only three reduced their number of
company stores to zero. Six companies increased their number of company-owned
stores.
Table #2: Variation of Franchised Stores in Quick Service Chains
Chain Company Stores Franchised Stores % Franchised
1988 1997 1988 1997 1988 1997
McDonald's 1758 1798 6149 10582 78% 85%
Pizza Hut 2770 3823 2937 4875 51% 56%
Burger King 758 514 4454 7025 85% 93%
Kentucky Fried Chicken 1262 1850 3637 3270 74% 64%
Domino's Pizza 1370 766 3665 3543 73% 82%
Wendy's 1076 1140 2445 3435 69% 75%
Hardee's 1038 863 2038 2081 66% 71%
Taco Bell 1691 2149 1187 4619 41% 68%
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Subway 30 0 2828 11165 99% 100%
Little Caesar's 488 1265 1636 3560 77% 74%
Arby's 209 0 1840 2925 90% 100%
Long John Silver's 1007 909 462 486 31% 35%
Dunkin' Donuts 16 0 1427 3436 99% 100%
Church's 998 480 283 590 22% 55%
Denny's 1001 884 233 708 19% 44%
Sources: The 1988 and 1997 Technomic Top 100
Before listing the factors that affect the choice of a franchising agreement by these
companies, I will list the types of franchising agreements that the companies use. This
will have the effect of providing the reader with an understanding of the types of
franchising agreements used by the two companies. Additionally, this will provide the
reader with visibility on the franchising agreements that the two companies have found
to be most relevant to their business, because we may find that some of the
agreements they use have yet to be identified by academics.
To summarize, this thesis will result in two contributions:
A comparison between the types of franchising agreements identified in the
literature and the types of franchising agreements that are used by the two
companies studied.
A framework that shows what leads to company ownership along with
frameworks that show how each factor affects the companies' propensity to use
one type of franchising agreement over the others.
Research Question
In order to fulfill the purpose of this thesis, the following research question has been
formulated:
What factors are taken into consideration by companies in their choice of an
outlet's organizational form?
By providing an answer to this question, this thesis will add knowledge to the field of
franchising, in particular to the agency and resource scarcity theoretical perspectives, by
giving academics valuable insight into current managerial practices. Additionally, this
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research will support informed decision-making in the future through an investigation of
this fundamental yet under-researched question.
Research Objects
In this section, I briefly introduce the companies that are going to be used in this study
with the purpose of providing the reader with a basic conception of what the companies
do and in which context they find themselves.
Two companies are going to be studied in the course of this case study. The first one,
which we will call FoodChain for the sake of anonymity, is a large quick service company
with operations all over the world. The second company, which we will call Art4Everyone
for the sake of anonymity, is a small company which owns art galleries in Europe, North
America and Africa. The fact that there are important differences between the two
companies will allow me to illustrate the same problem from different empirical positions
while maintaining depth, which is paramount (Siggelkow, 2007).
The quick service company is one of the world's largest chain of quick service
restaurants with operations all over the world. Over the last 55 years, FoodChain has
truly established a worldwide presence with restaurants in more than 100 countries. The
company has a particularly important presence in North America where more than 60%
of its restaurants are located. Most of the persons that are going to be interviewed for
the purpose of this study work for the Canadian subsidiary of this large quick service
chain.
FoodChain's menu is adapted to local tastes and customers to some extent. For
example, the company would have difficulty selling hamburgers in India because Hindu
people don't eat beef. Therefore, the Indian subsidiary sells burgers made of lamb as
well as vegetarian burgers. The fact that the company is willing to adapt to the local
culture is a big part of its success worldwide. Another part of the locally-relevant
restaurant experience that the chain wishes to provide comes from the fact that the
majority of its restaurants worldwide are independently owned and operated by local
men and women. Of all FoodChain restaurants worldwide, 60% are conventional
franchises, 20% are licensed to foreign affiliates or developmental licensees, and 20%
are company-operated.
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The second company, Art4Everyone, is fairly young and its business model is quite
innovative. In short, photographers all over the world can take photographs and submit
them to the company. If the company likes ones of the photographs then it purchases
the rights to it from the artist and prints a certain number of copies. The photographs
are exclusive to the company and cannot be found anywhere else.
The idea is to make great pictures more easily available to people all over the world.
The company prefers to sell many copies of a picture at a lower price then to sell just a
few copies at a higher price. The entire collection of photographs can be found on the
company's website. The company is growing quite fast with more than 30 galleries
already and another half-dozen slated to open in late 2012. Most of the galleries are
located in Europe but the international expansion has started and galleries are opening
in the United States, Canada, Russia, Mexico and more. Approximately 15 of the
galleries are owned by franchisees and the rest are owned by the company.
Delimitations and Limitations
Certain delimitations have been identified to provide this study with the desired amount
of focus. The first delimitation is that this study will not try to prove that one of the
franchising agreements is better than the others. I am of the opinion that every
franchising agreement can be best under certain circumstances, not that a certain
franchising agreement is always best. What this study will do is try to understand what
circumstances lead to a franchising agreement being used by the companies. Similarly,
there is a distinction to be made between the "best" franchising agreement and the
franchising agreement that is actually used by the company. Circumstances outside of a
firm's control may force it to use a franchising agreement which it would not necessarily
have used otherwise. Hence, this thesis will try to identify what circumstances would
generally lead a company to choose one type of franchising agreement over another.
Looking at what leads to franchising agreements being used, rather than what makes a
certain franchising agreement the best gives this thesis a more practical, realistic
approach as in real life events happen that force companies to adjust their strategy, and
use plan B or C.
The second delimitation of this study is that no attempt will be made to list all of the
special circumstances that could lead a company to use a certain type of franchising
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agreement over another. Instead, the study will attempt to capture the circumstances
that happen the most frequently according to the interviewees. This is for the sake of
conciseness as well as due to time constraints.
Finally, the last delimitation of this study is that the factors affecting the two companies'
decisions are going to be analyzed separately; no attempt will be made to compare
them. Attempting to analyze and integrate information about such different companies
into a single framework would be very messy and would lead to a loss of the
particularities of each company's franchising strategy.
These delimitations, in turn, bring certain limitations to this study. The first limitation of
this study is that because of the time limit and the need to go into depth, only two firms
are going to be studied (FoodChain and Art4Everyone). Studying more firms would have
been too time consuming and would not have allowed for as much depth, which would
have negatively affected the usefulness of this study.
This leads to the second limitation, that the results may not be generalizable to other
companies or industries. Unfortunately, one of the limitations of case studies is that they
are not recognized as being representative of the general population as they only
involve a few individuals (or entities). Case studies are a descriptive method more so
than an explanatory one, though they have strength in interpretation. Without controlled
conditions, conclusions about cause-and-effect relationships can't be drawn with
certainty. However, I believe that they can tell us about situations beyond the case
under study. Hodkinson (2001) adds that "case studies can provide provisional truths, in
a Popperian sense". He argues that the best theory thus far should stand until
contradictory findings or better theorizing has been developed.
Thesis Structure
This paper consists of an introduction (of which this paragraph is a part of) and five
other chapters. The following chapters are organized as follows: First, the agency
theory, resource scarcity theory and plural form in franchising literature will be reviewed.
Next, the choice of a research object and research design, along with the research
method are going to be explained in more details. In the following section, the empirical
findings are going to be shared. Then, those findings will be analyzed and discussed in
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the analysis and discussion section. Finally, conclusions from the study are drawn,
theoretical and practical implications for franchisors and academicians are extracted
from the results and recommendations are made for future research opportunities.
Theory
Literature Review
During my literature review, I found that very little research had taken place on the
different types of franchising agreements used by companies as well as on the
conditions that lead franchisors to choose one over the others. While researchers have
looked at the reasons that lead companies to choose franchising over company
ownership, they have not really looked closely at the rationale behind the choice of
specific franchising agreements. The four main themes in recent franchising research
are the following, as shown in the conceptual map of franchising research shown below:
Antecedents to franchising (what leads to franchising being used)
Consequences of franchising (determinants of firm performance and success or
failure as well as direct consequences of franchising on franchisees and
franchisors)
Moderators of the franchising relationships (factors that influence the nature and
strength of the antecedents–franchising relationship as well as conditions under
which franchising enhances outcomes)
Evolution of franchising and its use in different national contexts
Table #3: A Conceptual Map of Franchising Research
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(Combs et al, 2011)
Seeing as there is a gap in research when it comes to the different types of franchising
agreements that exist and the conditions under which franchisors choose one
agreement over the others, this thesis will endeavor to enhance the knowledge in those
areas. The following section will summarize the theories that are going to be used in the
discussion and analysis section to explain why certain factors may be considered by
franchisees as they decide which organizational form they wish to use. First, the
resource scarcity theory is going to be summarized. In the second section, agency
theory is going to be described. Then, a brief summary of the plural form in franchising
will be given as this theoretical perspective is mostly going to be used as a support.
Finally, an overview of what we currently know about factors affecting a franchisor's
propensity to use a specific franchise agreement is going to be summarized.
Resource Scarcity Theory
The resource scarcity theory, initially proposed by Oxenfeldt and Kelly in 1969, is often
used to explain franchising decisions. It begins with the premise that franchising is used
early in a firm's existence to promote rapid growth to create economies of scale in
advertising and purchasing. This leads to two predictions. The first is that franchising is
used as a way to overcome limitations to growth. The second is that once economies of
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scale have been attained, franchisors will maintain ownership over the most profitable
outlets and eventually repurchase all but the least profitable outlets.
In their analysis, Oxenfeldt and Kelly (1969) described two conceptual frameworks that
suggested the basic forces that tend to encourage successful franchisors to move
strongly, over time, toward ownership of their more profitable outlets: the "push-pull"
model and the "life-cycle" framework. First, I will start by summarizing these two
conceptual frameworks. Then, I will summarize the predictions made by the resource
scarcity theory as well as the extent to which they have found support thus far.
Push-Pull Model
Oxenfeldt and Kelly (1969) claim that "to explain and predict change, one should search
out the forces that induce the parties to change their existing situation - difficulties that
push them to make a change, and those that attract the parties to another situation -
and pull them toward the new." They use the push-pull model to describe the factors
that lead firms to try and repurchase franchises as well as the factors that lead
franchisees to sell profitable businesses. Oxenfeldt and Kelly (1969) identify four basic
underlying forces that could lead a firm to purchase a franchise: goals, resources,
opportunities and frustrations.
Goals: The main reason why companies decide to repurchase franchises is because
ultimately they believe that doing so is going to create the most value for shareholders
over the long term.
Opportunities: Another factor that pushes franchisors toward ownership is the fact that
opportunities (such as technological change) that call for remodeling and updating of
operations sometimes come up and it's easier for the franchisor to grasp those
opportunities and apply them to the outlets if he owns them.
Resources: Scarcity of capital or managerial talent may lead the franchisor to rely on
franchising to reach a critical size more rapidly (which allows for the enjoyment of
economies of scale in information systems, advertising, purchasing and more). Once
resources are not scarce anymore then the franchisor, who does not need to rely on
franchisees anymore, is free to repurchase franchises.
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Frustrations: Maintaining consistent quality and service standards is of critical
importance to the success of a franchisor. Unfortunately for the franchisor, it is difficult
to exercise close control over independent franchisees. Oxenfeldt and Kelly (1969) state
that "failure to get franchisees to adapt their actions to the franchisor's overall programs
can be very damaging to the success of these programs". This can push franchisors
toward converting franchises to company ownership.
As was just explained, there are plenty of reasons why a company could decide to
purchase an outlet from a franchisee but one could wonder why a franchisee could want
to sell a profitable business. Oxenfeldt and Kelly identify four basic underlying forces
that could lead a franchisee to sell a profitable franchise: goals, resources, opportunities
and frustrations.
Goals: One of the factors that could push a franchisee toward the sale of his franchise is
a desire for independence. A common characteristic of franchisees is their goal of
working on their own.
Resources: Another factor that could lead a franchisee to sell is the attractiveness of the
selling price and the capital it places at the franchisee's disposal.
Opportunities: Linked to resources, the franchisee may have more attractive uses for the
capital, which would heighten the wish for change.
Frustrations: If the franchisee feels frustrated by the franchisor's policies and control
system then this would definitely serve as a motivator for change.
Once the decision has been made to sell, it is much easier for the franchisee to sell back
to the franchisor than to anyone else for many of reasons. First, he may be contractually
obligated to do so. Even if he isn't, the franchisor may have the power to veto his choice
based on the buyer's failure to meet the franchisor's requirements. Selling to the
franchisor minimizes the problems and costs linked to the transfer of ownership, such as
advertising costs, issues of trust, valuation of the franchise and more.
Life-Cycle Model
Oxenfeldt and Kelly use the life-cycle model to explain why, as time progresses, the
goals, opportunities and capabilities of the franchisor and franchisee may change which
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can explain why a firm could choose to sell a franchise early on and then repurchase the
same franchise a few years down the road.
The franchisor's primary objectives remain the same at all stages (profitability and
growth), but other objectives which may change over time. First, some franchisors may
wish to run a wholly-owned operation from the start but initially lack the resources to do
so. Hence, they franchise to penetrate the market as widely and rapidly as possible.
"Once the desired initial coverage is attained, their emphasis shifts toward operating
efficiencies and market development, both of which can best be attained through the
tight control permitted by ownership" (Oxenfeldt and Kelly, 1969).
The capabilities and resources of the franchisors also change as time progresses. At
first, the franchisor is largely ignorant about local conditions and frequently lacks capital
and skilled management. In time, he usually manages to overcome these deficiencies.
His capital position and ability to raise additional funds improve with success and
knowledge of local conditions is gathered through their contact with the franchisee. His
ability to recognize the key characteristics required for his personnel also grows. He can
also reduce his dependence on local personnel by centralizing activities that were initially
carried out locally (Oxenfeldt and Kelly, 1969).
The franchisor's opportunities also change over time. Initially, he is faced with the
opportunity of preempting attractive territories. He seizes this opportunity by enlisting
franchisees to his cause, which allows him to overcome his capital shortage. Eventually,
he exhausts this line of expansion and finds himself facing increasing competition which
puts pressure on profits. In response to this development, he acquires some outlets (the
most profitable ones) and leaves the less profitable ones to franchisees (Oxenfeldt and
Kelly, 1969).
Just as the franchisor's goals, capabilities and opportunities change as the business
matures, so do the franchisee's. Initially, the franchisee may be primarily interested in
obtaining an outlet which would provide some security while also giving him partial
autonomy. As he prospers, his monetary needs become less pressing while his desire for
identity grows. As he becomes more established, he starts seeking more independence.
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Several forces may move him to sell out such as the desire for the easy life or the lack
of a successor.
The franchisee's capabilities also change over time. At first, his major strengths may be
his ambition, willingness to work hard, local knowledge and finances. At that point in
time, he may initially welcome the close attention and training provided by the
franchisor. Through time, as his managerial skills improve, his self-esteem grows. This
increase in self-esteem, combined enhanced financial capabilities, makes him start
resenting the constraints placed upon his actions by the franchisor. In the maturity
stage, he finds that he no longer has the drive or stamina to work long hours. This
development is an additional motivation to sell.
The opportunities facing the franchisee also change over time. "At first, he seizes the
opportunity to own a franchise that could lead to good profits in exchange for taking on
a little risk and investing some of his money. As he makes money during the growth and
prosperity stages, his opportunities for investment elsewhere expand if for no other
reason that his increased resources" (Oxenfeldt and Kelly, 1969). They add that the
more attractive other investment opportunities are and the more likely the franchisee
will be likely to sell out.
Oxenfeldt and Kelly (1969) conclude by adding that when a franchise is purchased back
by the franchisor, it reflects a match between the franchisor's and the franchisee's goals,
opportunities and resources.
Predictions made by Resource Scarcity Theory and Recent Insights
Taking the push-pull model and the life-cycle model and combining them brings us to
the two predictions made by resource scarcity theory. First, resource scarcity theory
predicts that firms will turn to franchising to build outlets and supply needed managerial
expertise and local knowledge (because firms do not have the capital to do so and
because they wish to benefit from economies of scale in advertising and purchasing). At
its core, this prediction suggests that franchising is a way to overcome internal
limitations in terms of capital and in terms of the time it takes to train managers. These
limitations are highly correlated with Aldrich's and Auster's work on the liabilities of
smallness (Aldrich and Auster, 1986). In short, the argument was made that small
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companies have difficulties raising capital, major disadvantages in competing for labor
with larger organizations and limited abilities to obtain benefits from specializations and
economies of scale (Freeman and Hannan, 1983). Hence, franchising could be seen as a
way to overcome some of the liabilities of smallness. This is quite important as the rate
of failure for new ventures is much greater than it is for mature firms, therefore
franchising could be a way to reach maturity more quickly which would increase their
chances of survival. According to the Small Business Association (SBA), 30% of new
businesses fail during the first two years of being open, 50% during the first five years
and 66% during the first 10. Only 25% of new businesses make it to 15 years or more
(Small Business Association, 2011).
The second prediction of resource scarcity is that once economies of scale have been
attained, franchisors will maintain company ownership over new outlets and eventually
repurchase all but the least profitable franchised outlets (a phenomenon also known as
ownership redirection) (Oxenfeldt and Kelly, 1969). Hence, franchising could be seen as
a way to overcome the liabilities of smallness and once those liabilities are overcome the
franchisor will prefer to go back to a wholly-owned system.
While the first prediction of resource scarcity has found support, the second prediction
of resource scarcity has been contested by many academics (Combs and Ketchen,
2003). The results of research conducted on the subject have been quite mixed (Combs
et al, 2011). Early evidence actually pointed toward a reduction in the use of franchising
among large firms (Hunt, 1973) and within maturing industries (Caves and Murphy,
1976). However, Martin (1988) found that the balance between company-owned and
franchised outlets does not appear to approach full-ownership over time. The results of
several studies actually contradicted the second prediction of resources scarcity. For
example, Dant and Kaufmann (2003) found no evidence of ownership redirection when
examining changes in the overall proportion of franchised outlets among 109 franchisors
while Lafontaine and Shaw’s (2005) analysis of a 17-year panel of over 5,000 franchisors
found that a firm’s proportion of franchised outlets stabilizes after about 6 years and
remains steady.
However, some studies did find that a subset of established franchisors were actively
converting franchised outlets to company ownership (Combs, Ketchen, and Hoover,
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2004). One of the implication of these findings is that since some found evidence of
ownership redirection and some didn't, one could propound that there are certain
conditions that can lead to ownership redirection taking place. This led academics to try
and identify some of those conditions, some of which have already been identified. For
example, Windsperger and Dant (2006) found that ownership redirection is more likely
to take place when what the franchisee brings to the relationship is contractible. Combs
and Ketchen (1999) found that foreign expansion, asset specificity and capital scarcity
have a positive impact on the degree of franchised units, while specific knowledge has a
negative impact on the degree of franchised units. Additionally, Bürkle and Posselt
(2008) posit that franchising shifts the risk to the franchisee, but that the benefit of
franchising for the franchisor declines as the proportion of outlets grows. This declining
benefit offers an incentive for ownership redirection.
To summarize, many studies have been conducted to see if the predictions made by
resource scarcity theory would hold. The first prediction, that firms franchise to grow
and build economies of scale in purchasing and advertising, has found some support.
However, the second prediction, which is that once economies of scale have been
attained, franchisors will maintain company ownership over new outlets and eventually
repurchase all but the least profitable franchised outlets, has been contested by many
academics.
Agency Theory
"The directors of such [joint-stock] companies, however, being the managers rather of other
people’s money than of their own, it cannot well be expected, that they should watch over it with
the same anxious vigilance with which the partners in a private copartnery frequently watch over
their own. Like the stewards of a rich man, they are apt to consider attention to small matters as
not for their master’s honor, and very easily give themselves a dispensation from having it.
Negligence and profusion, therefore, must always prevail, more or less, in the management of
the affairs of such a company."
- Adam Smith (1776)
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Many aspects of organizational theory developed by modern economists were actually
derived from Adam Smith's "Wealth of Nations" in 1776. Agency theory is no exception
to this, as the quote shown above summarizes very well what agency theory is about.
An agency relationship is "a contract relationship in which one or more persons (the
principal) engage another person (the agent) to perform some service on their behalf
which involves delegating some decision-making authority to the agent." If both parties
in the relationship are utility maximizers, there is good reason to believe that the agent
will not always act in the best interests of the principal (Jensen and Meckling, 1976).
Seeing as the agent's and the principal's interests may diverge, the principal has to
identify the lowest cost arrangement that will align the agent's interests with his own
(Combs et al, 2011).
There are two problems linked to agency theory. First is the agency problem which
arises when the desires or goals of the agent differ from those of the principal and when
it is difficult or expensive for the principal to verify what the agent is doing (because in
that case the agent can act in his own interest without the principal's knowledge).
Second is the problem of risk-sharing which arises when the principal and the agent
have different attitudes toward risk which means that they could favor different actions
due to their different risk preferences.
Agency theory is then interested in determining the most efficient contract governing
the principal-agent relationship. More specifically, agency theory is interested in
determining whether a behavior-oriented contract (salary, etc.) is more efficient then an
outcome-oriented contract (commissions, stock options, etc) without shifting risk
unnecessarily to the agent. Agency theory can be applied to a variety of organizational
phenomena. Overall, the domain of agency theory is relationships that mirror the basic
agency structure of a principal and an agent who are engaged in cooperative behavior,
but have differing goals and differing attitudes toward risk (Eisenhardt, 1989).
Two Streams: Positivist Agency Theory and Principal-Agent Research
Taking a deeper look at the agency literature, there are actually two different streams:
Positivist Agency Theory and Principal-Agent Research. First, positivist research has
focused on identifying situations in which the principal and agent are likely to have
conflicting goals and then describing the governance mechanisms that limit the agent's
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self-serving behavior (Eisenhardt, 1989). Two governance mechanisms that can solve
the agency problem have been identified. The first is the use of outcome-based
contracts, which can be effective in curbing agent opportunism because they coalign the
preferences of agents with those of the principal because the rewards given to the agent
depends on the attainment of objectives set by the principal. The second proposition is
the use of information systems, which curbs agent opportunism by allowing the principal
to verify agent behavior, lessening the likelihood of the agent acting against the
principal's interests. The theory is almost exclusively focused on the principal-agent
relationship between owners and managers of large corporations. The positivist stream
is most concerned with describing the governance mechanism that solve the agency
problem.
The second stream in the agency theory literature is the principal-agent research
stream, which is concerned with a general theory of principal-agent and has a much
broader focus than the positivist stream. The focus of the principal-agent literature is on
determining the optimal contract (behavior-based or outcome-based contract) between
the principal and the agent. The heart of principal-agent theory is the trade-off between
the cost of measuring behavior and the cost of measuring outcomes and transferring
risk to the agent (Eisenhardt, 1989).
Agency Cost
Jensen and Meckling (1976) define agency costs as the sum of the monitoring
expenditures by the principal, the bonding expenditures by the agent and the residual
loss. In other words, agency costs are costs which come from the separation of
ownership and control. These costs would not be necessary if ownership and control
resided within the same people's hands. Since that is not the case, those three costs
must be borne by the principal and agent.
Monitoring expenditures are incurred by the principal when he attempts to monitor the
actions of the agent. For example, he may put in place a board of director to whom the
agent will have to answer to, or he could set up an IT system which would give him
more visibility on how the business is run. Bonding costs are incurred by the agent as he
commits to contractual obligations that may limit or restrict his activities. For example,
he may have to agree to forego other potential employment opportunities. Finally,
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residual losses are the costs incurred from divergent principal and agent interests
despite the use of monitoring and bonding.
The Plural Form in Franchising
The plural form is a concept that was initially proposed by Bradach and Eccles (1989).
Most of the work in the economic theory of organizations asks which organizational
arrangement is optimal under given circumstances. This question is generally answered
by the author saying that one structure is found to do better than the others. The idea
behind the plural form is that sometimes, a combination of organizational arrangements
may actually be better than the use of a single organizational arrangement, because
those organizational arrangements may possess a synergism when used simultaneously
(Lewin-Solomons, 2000).
Lewin-Solomons posits that chains value their franchisees because franchisees exercise
initiative in their stores. Some of the initiatives lead to increased efficiency and to
innovative ideas which can be spread to the chain as a whole. However, there is a
potential conflict here because franchisees care about profits while franchisors care
about revenues, as the royalty fee is based off of revenue. Since the royalty paid by
franchisees depends on revenues alone, a firm might be biased in favor of innovations
that are good for revenues, even if overall profits suffer, while franchisees would prefer
innovations that decrease costs or that increase revenues in relation to costs. By
maintaining a certain proportion of company-owned stores, the corporation can show
franchisees that it is not asking them to implement innovations which it is not willing to
implement itself (Lewin-Solomons, 2000).
The differences between franchises and company stores are mostly related to how such
stores are run. Franchisees will be much more motivated to find ways to increase profits
because they get to keep all of the profits (minus the royalty fee). A salaried manager's
incentives, on the other hand, are much weaker because additional profits resulting from
over performance go to the company, for the most part. Also, going off the beaten path
could work against his objective of advancing within the corporate hierarchy where one
must focus on obeying to authority and not making waves.
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Companies generally give franchisees a lot more leeway than company managers
because they know that franchisees can be trusted to make good decisions because
"basically their whole life is at stake, in terms of what they do in their restaurants, so
they seem to be a little more calculated in their risk-taking, whereas company managers
"don't own the building, the business" and are therefore more willing to take
irresponsible risks (Lewin-Solomons, 2000).
To summarize, the plural form believes that the use of both company-owned stores and
franchises could be justified, since the attributes of franchises and the way franchisees
run them can be leveraged by company-owned stores and vice versa.
Gaps in Previous Research
So far, little research has taken place on factors that affect the type of franchising
agreement used. The three theories described in this section look at what leads to
franchising being used by firms. These theories do not go so far as to explain specifically
which type of franchising agreement will be used by those firms. In fact, it seems that
even research that has taken place on specific franchising agreements has overlooked
the ownership strategy. For example, Hussain and Windsperger (2010) found that while
several empirical studies have been published on multi-unit franchising, the research
deficit primarily results from the lack of theoretical foundation of this ownership
strategy.
Following Hussain and Windsperger's study, some academics looked into factors that led
franchisors to choose multi-unit franchising over single-unit franchising using agency
theory as their main theoretical perspective. For example, Gomez, Gonzalez and
Vázquez (2010) identified certain factors that affected the franchisor's decision to grant
units to existing franchisees (therefore using multi-unit franchising) or to grant units to
new franchisees (hereby using single-unit franchising). Their main conclusion was that
they related the use of multi-unit franchising to the existence of agency problems in the
franchisor-franchisee relationship. They proposed that franchisors use multi-unit
franchising as an incentive mechanism to reduce the adverse selection risk and the
moral hazard risk. They found that geographical concentration, size of the network and
a non-repetitive customer base had an effect on the usage of multi-unit franchising.
Additionally, Hussain and Windsperger (2011) found that franchisor's multi-unit
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franchising strategy can be explained by monitoring costs, franchisee's transaction-
specific investments, franchisor's system-specific assets, and franchisor's financial
resources scarcity. Hussain et al. (2012) found that transaction cost explanations can
complement the agency cost explanation of multi-unit franchising.
While some research has started taking place on how certain factors can lead companies
to use multi-unit franchising instead of single-unit franchising, there is a gap in research
as studies so far have overlooked other types of franchising agreements. Additionally,
the main theoretical perspectives that have been used so far are agency theory
(primarily) and transaction cost explanations but other important theories seem to have
been overlooked.
I firmly believe that my investigation can make a valuable contribution to the field
because it will give an alternative perspective on the topic. First, my investigation will
not only take into consideration single-unit and multi-unit franchising but also other
types of franchising agreements used by corporations. While single-unit and multi-unit
franchising are the types of franchising agreements that are most commonly used by
companies, other types of franchising agreements are also used by firms. In fact, I
believe that it would be particularly interesting to understand what leads franchisors to
go off the beaten path and use other types of franchising agreements. Studies that have
only tried to compare what leads companies to choose multi-unit over single-unit
franchising have probably overlooked factors that lead companies to choose other
franchising agreements. Additionally, this thesis will consider company-ownership
alongside of the various franchising agreements as companies do not necessarily stop
owning outlets once they start franchising. Company-ownership always remains an
option. Finally, the main theoretical perspectives that have been used so far by
academics are agency theory and transaction cost explanations, but other important
theories seem to have been overlooked (particularly resource scarcity theory). I will
cover the topic using the agency theory, resource scarcity and plural form theoretical
perspectives.
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Research Methodology
In this chapter, I start by explaining why I chose to do exploratory research instead of
causal or descriptive research. I then explain why it is that I chose to do a multiple-case
study and describe how it is that the two companies were selected as research objects
for this thesis, as well as how the empirical study was conducted. More specifically, I
describe how I chose to do a qualitative explorative study and how the empirical data
was gathered and analyzed. I conclude the chapter by describing alternative research
methods that I considered and by listing the main limitations and delimitations of this
study.
Research Method
The purpose of this study is to close the gap that has been found in research in terms of
what factors affect the elaboration of a franchising strategy in order to provide readers
with valuable insights into current managerial practices as well as support informed
decision-making in the future. Indeed, academics have focused on the antecedents,
consequences and moderators of franchising but some subjects still remain under-
researched. I will try to enhance knowledge on the answer to a question which has been
overlooked so far in research: What factors are taken into consideration by companies in
their choice of an outlet's organizational form?
Once the choice had been made to answer this research question, the question of how
to conduct this study emerged. The first step was to decide which type of research this
study represented: causal, descriptive or exploratory. Causal research is undertaken to
find out whether any relationship exists between two variables. Descriptive research is
when a problem has already been identified and the researcher knows precisely what
has to be studied and where to find the solution. Finally, exploratory research is when
the researcher does not know what the problem is (or if there even is a problem) and he
mostly tries to gather information and enhance knowledge on a topic which has thus far
received very little attention from other academics.
I chose to undertake exploratory research as this research question has been under-
researched and I currently do not know what the problem is or if there even is one. This
thesis will try to enhance knowledge on the factors affecting the choice of a specific
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organizational form for an outlet (company ownership or specific types of franchising
agreements) so that in the future descriptive research and causal research can take
place without starting from scratch.
Research Design
Once I had chosen the research question and made the decision to research it from an
exploratory stand point, the logical next step was to decide upon which research design
to use. The benefit of having thoroughly evaluated different alternatives and their
benefits and drawbacks can be described as providing a framework for the collection
and analysis of data (Bryman & Bell, 2007).
According to Bryman and Bell (2007) there are five different types of research designs:
experimental design, cross-sectional (or social survey) design, longitudinal design,
comparative design and case study design. In order to figure out which one I would use,
I used the process of elimination. First, I eliminated the longitudinal research design,
arguing that it cannot be applied properly to my particular study. Normally, longitudinal
studies involve repeated observations of the same variables over many years. This was
not feasible as I had a limited amount of time to write this thesis. I also found that an
experimental design simply did not really apply to my particular choice of focus as it
requires a level of control that is hard to establish when dealing with organizational
behavior (Bryman and Bell, 2007). A cross-sectional research design also had to be
eliminated as it was not suitable for the topic of this thesis. The data collected using
cross-sectional designs is generally quantitative (or quantifiable). The topic that will be
under study is much more qualitative than it is quantitative. This left me with two main
options: case-study design and comparative design.
I ultimately chose to use a case study design because I felt that this type of design was
better suited to explorative research than a comparative design (which I feel is best
used when more is known about a phenomenon). I contemplated using a single-case
study approach but ultimately decided not to, following advice from my thesis
supervisor. Using only one company for the study meant only being of interest to
companies similar to that company and I wanted the study to be of interest to a broad
audience. I also knew that a multiple case study would allow me to paint a much more
complete picture of the phenomenon while also ensuring a more balanced approach to
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my object of study (Grix, 2001). The single-case study design should only be when the
case under study is extreme, unique, revelatory, or representative. The case should be
an "object of interest in its own right, and the researchers [should] aim to provide an in-
depth elucidation of it" (Bryman and Bell, 2007). Additionally, practical limitations such
as the difficulty of finding a company willing to let me conduct approximately 20
interviews with its employees, finally led me to conduct a multiple case study. I briefly
considered studying more than two companies but I ultimately chose not to do so as the
time requirement on my part would have been enormous and the companies and their
processes would have been studied in less depth.
Case studies have received quite a bit of criticism over the past few decades. As Hamel
(1993) observes, "the case study has basically been faulted for its lack of
representativeness and its lack of rigor in the collection, construction, and analysis of
the empirical materials that give rise to this study." In defense of case studies, Shields
(2007) argues: "The strength of qualitative approaches is that they account for and
include difference--ideologically, epistemologically, methodologically--and most
importantly, humanly. They do not attempt to eliminate what cannot be discounted.
They do not attempt to simplify what cannot be simplified. Thus, it is precisely because
case studies include paradoxes and acknowledge that there are no simple answers, that
it can and should qualify as the gold standard." Flyvberg (2006) also argues in favor of
case studies. He argues that universals can't be found in the study of human affairs,
hence that context dependent-knowledge is more valuable than general knowledge. He
adds that formal generalization is overvalued as a source of scientific development and
that the force of a single example is underestimated.
Choice of a Research Object
Once the choice had been made to do a case-study with two companies, the appropriate
next step was to come up with a list of criteria that the companies had to meet to make
sure that the thesis added the most value for academics and managers. To come up
with this list of criteria, I started by looking at the research question that I had chosen
to see what sort of company would be able to give input on this matter:
What factors are taken into consideration by companies in their choice of an outlet's
organizational form?
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My first thought was that to give insight into the elaboration of their franchising
strategy, a company needed franchising experience.
Hence, my first criterion was that the company needed to currently have a
certain number of franchises.
Second, I absolutely needed to have easy access to someone whose job had to do with
their franchising strategy and who would be able to give me access to people and
documentation. After all, "the biggest problem students have with interviews is access to
individuals, companies or institutions" (Grix, 2001).
Hence, my second criteria was that I needed to know someone in the company
who worked on some aspect of the company's franchising strategy and who
would be able to refer me to the right people.
Also, seeing as I wanted the study to be relevant to many people (academics and
owners), the companies had to be different enough from each other that many
companies outside of this study could identify themselves to the companies in the study
to some extent.
Hence, my third criterion was that the companies had to be different from each
other in terms of size and age.
Using the above three criteria, I created a short list of companies that I could approach
to see if they would be willing to answer my questions. After approaching them and
assessing the extent to which I believed they would be willing to give me access to
sensitive information, I ended up choosing two companies with widely different
backgrounds. Both of these companies were willing to let me go through confidential
documentation as well as interview several people within the organization as long as
they were allowed to keep their anonymity. Consequently, certain details about the
companies and the respondents will be removed or replaced with slightly different
information to ensure that their anonymity remains complete. Of course, any
information that could have a material effect on this thesis' findings will be kept as is.
The first company that is going to be studied in this case study is a large quick service
company with operations all over the world. For the purpose of this study we will call
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this company "FoodChain". FoodChain met all three criteria mentioned above. First, the
company has a lot of franchising experience. Indeed, the company has thousands of
franchised stores and it is still expanding. The company uses company ownership as well
as a variety of franchising agreements, meaning that interviewees will be able to provide
information on various types of franchising agreements, as well as what makes them
choose one franchising agreement over the others. FoodChain also met the second
criteria, which was that I had to know someone in the company whose work was related
to franchising and who would be able to give me access to people and documentation.
Seeing as I had a good relationship with someone who just happened to be in an upper
management position and actually used to be in charge of the franchising aspect of the
business, using FoodChain for the case study made perfect sense.
The second company that is going to be studied in this case study is a smaller company
based in France which owns approximately 35 art galleries in Europe, North America and
Africa. For the purpose of this study, the company will be called Art4Everyone. Despite
being a fairly young company (approximately 5 years old), the company is currently
expanding aggressively internationally using a combination of franchising and company
ownership. Art4Everyone also met the second criteria, which was that I had to know
someone whose work was related to franchising and who would able to give me access
to documentation and people. I personally knew the person in charge of negotiating the
franchising agreements with potential franchisees in North America. He will be able to
provide me with a lot of insight on the factors that lead him to choose one type of
franchising agreement over another as well as give me access to people who helped
elaborate the franchising strategy or who apply it in other regions.
The final criterion was that the two companies had to be different enough that this
thesis would be of interest to companies of different sizes, ages and operating in
different industries. This is the case as FoodChain is a large, mature quick service
company with operations all over the world while Art4Everyone is a young company with
a few dozen outlets in the art industry.
The fact that these companies are quite different makes this thesis a lot more
interesting to academics and owners in general as the topic of franchising agreements is
going to be covered both from the point of view of a large, mature multinational
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corporation and from the point of view of a smaller, more entrepreneurial organization
in its infancy. Had a single company been studied, the target audience would have been
much smaller as the findings would have been applicable to fewer companies.
Qualitative Approach
On a conceptual level, there are two overarching kinds of research strategies:
quantitative and qualitative research methods. There are several distinctions between
the two, and it's important to understand that they each have their strengths and their
weaknesses and that one is not necessarily better than the other.
A common way to distinguish the two types of research strategies broadly is to define a
quantitative strategy as one that uses statistical methods to analyze the collected data
while a qualitative strategy involves using other methods to analyze data (Bryman &
Bell, 2007). The most important parameter to consider when choosing which strategy to
use in a particular study is to look at the kind of data that needs to be analyzed that
could help answer the research question in the most satisfying way.
According to the stated distinction between a quantitative and a qualitative study, the
study I have proposed would fall under the label of a qualitative study. My proposed
research question, what factors are taken into consideration by companies in their
choice of an organizational form for an outlet, does not have a quantitative component
at all and there is no numerical data available, thus it would not make sense to use
quantitative study methods. A qualitative research strategy is much better suited to my
study as it allows me to use in-depth interviews as my primary source for data collection
(Mack and Woodsong, 2005).
Ritchie and Lewis (2003) add that "the aims of qualitative research are generally
directed at providing an in-depth and interpreted understanding of the social world by
learning about people's social and material circumstances, their experiences,
perspectives and histories" (Richie and Lewis, 2003) and that is precisely what I am
trying to achieve with the chosen research question.
Data Collection
When collecting exploratory primary data, a researcher can use a number of different
methods. Interviews, observations and internal documents are examples of commonly
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used sources of primary information. In order to answer this research question, it made
more sense to rely mainly on interviews to answer the research question as I wish to
provide an in-depth understanding of what factors affect the elaboration of a franchising
strategy and that can only be done by gathering and sharing the thoughts of the people
in charge of elaborating and applying the two companies' franchising strategies. I will
complement these interviews with internal documentation that will be made available by
the interviewees.
Yin (2003) identified six sources of evidence that can be collected during case studies,
each having their own strengths and weaknesses, two of which I chose to use in this
case study. First, I chose to use interviews because there are especially good when
trying to reach in-depth understanding (my main objective) within a limited timeframe
(my main limitation) (Eisenhardt and Graebner, 2007). They are also quite useful for
gaining insight and context into a topic and they allow respondents to describe what is
important to them. Interviews can also provide information that is not printed or
recorded elsewhere and are particularly useful in interpreting complex decisions. The
second is documentation, which I have chosen because it is a very good source of
background information and it is unobtrusive (Yin, 2003). It is also stable, meaning that
it can be reviewed repeatedly, and exact. It was important for me not to use interviews
as the sole method in my study but rather to use interviews in conjunction with other
methods of enquiry. Looking at this phenomenon from different angles will ensure a
more balanced approach to my object of study (Grix, 2001).
Interviews
Once I made the decision to use interviews as a way of gathering information, I looked
at the various types of interviews to better understand what their respective strengths
and weaknesses were, and how I could maximize the quality of my findings. I found
that there are four main types of interview techniques that can be used: structured,
semi-structured and unstructured interviews as well as group interviews. The following
paragraphs will break down the reasons why I chose to use a mix of semi-structured
and unstructured interviews.
First, I should mention that I started out by eliminating group interviews because I felt
that group interviews didn't apply as well to the research question as the other type of
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interviews. I felt that group interviews would be difficult to use because many of the
interviewees that I identified were not local so the group interview would have to be
conducted over the phone. I also didn't think that group interviews were the best use of
the interviewees' time. After all, most FoodChain executives were only willing to grant
me between 30 minutes and an hour of their time and I figured that one-on-one
discussions with them would add a lot more value than holding a group interview in
which most wouldn't speak more than just a few words.
Then, I decided to rule out structured interviews because that they are much less
flexible than other types of interviews, which could lead me to miss out on important
information due to the fact that the questions in structured interviews are usually closed
and the technique is not designed to cope with the unexpected. They are also generally
used to generate quantitative data, which is not the type of data that I wish to collect.
I liked the idea of starting out with unstructured interviews at the beginning of my
research to let the interviewees talk about how franchising takes place in general. I
figured that this would open up avenues of investigation that I could have missed out on
otherwise. I would then move on to use semi-structured interviews that would let me
investigate questions which had been left unanswered during previous unstructured
interviews. I did not want to use only unstructured interviews as I feared that the data
gathered from the various interviews would be difficult if not impossible to compare. The
main advantage of semi-structured interviews is that it allows for the pursuit of
unexpected lines of enquiry during the interview yet the findings from those interviews
can still be compared.
I felt that using a mix of semi-structured and unstructured interviews would help me get
the best of both worlds. On one hand, the unstructured interviews would open up
avenues of investigation that I may have missed out on if I had only used semi-
structured interviews. On the other hand, semi-structured interviews would allow me to
gather information on specific topics and make it much easier to compare this
information.
Yin (2003) argued that interviews were the most importance source of evidence in case
studies but mentioned that there were four main weaknesses to interviews. I will have
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to develop a strategy that allows me to mitigate these weaknesses if I am to maximize
the quality of the inputs and outputs.
The first weakness of interviews is that there is a possibility of a response bias, which is
when interviewees tells the interviewer what he wants to hear, or when his personal
agenda makes him answer differently. To mitigate this weakness, I will grant the
interviewees (and the company) anonymity which will lessen the likelihood of their
personal agenda influencing their answers in order to protect themselves.
Second is that there are inaccuracies that could be due to poor recall - interviewees
sometimes don't remember precisely how they acted, what they thought or said and
why. In order to mitigate this risk, I will use other data collection methods (such as
reading internal documentation ahead of time to bring up information from the
documentation when necessary). I will also interview multiple people to get different
perspectives. If the information gathered during interviews differs then I will be able to
ask for clarifications.
The third and fourth weaknesses are interlinked. There is reflexivity which is when an
interviewee tells the interviewer what he wants to hear and there is a chance of bias
due to poorly constructed questions. Ensuring that questions are well constructed should
go a long way towards minimizing reflexivity on the interviewee's part. By ensuring that
the questions are well constructed, perfectly neutral and do not take anything for
granted, I should be able to minimize reflexivity.
As long as I remain aware of the weaknesses of interviews and that I follow the plans
laid out above to mitigate each of these weaknesses then I believe I should be able to
minimize their impact and the extent to which they occur.
Documentation
I wanted to have more than one data collection method to look at this phenomena from
different angles in order ensure a more balanced approach to my object of study (Grix,
2001) therefore I looked at the various sources of information that I could use along
with interviews. After eliminating archival records, participant-observation and physical
artifacts, I was left with documentation and direct observation as my main options.
Direct observation could have been added a lot of value to this thesis seeing as I would
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have been able to observe what actually takes place in real life and what aspects are
particularly important in the choice of a franchising agreement. However, it would not
be feasible for me to be present at meetings partly due to the fact that I work full-time,
not to mention that the decisions are made over the span of several meetings and
phone conversations. I also do not think that I would have been granted this type of
access, not to mention that the time commitment would have been enormous.
Hence, I came to the conclusion that using documentation as my secondary source of
information made the most sense. I also knew that the companies would have
documentation on the various franchising agreements that they use. Yin (2003) found
that documentation has four main strengths. First, it is stable: it can be reviewed
repeatedly and it never changes. Second, it is unobtrusive: it was not created as a result
of the case study; it was there before the case study ever took place. Third, it's exact: it
contains exact names, dates, references and details of an event. Finally, documentation
has a very broad coverage: information is collected over a long span of time, and many
events and settings are covered. Since documentation is totally unbiased, it helps
minimize the weaknesses of interviews, in particular the weakness related to response
bias.
I also found that the weaknesses of documentation that Yin (2003) found actually didn't
apply in my case. Blocked access, irretrievability and reporting bias could be problematic
for some but in this case my two sponsors both have access to the documentation that I
need therefore it should not be an issue. An advantage of the research question that
has been identified earlier in this thesis is that the answer is not something that could
compromise either organization. There is nothing to hide because the type of franchising
agreement used does not have a negative effect on franchisees, shareholders or clients
therefore there is no reason why access would be blocked, especially considering the
fact that the companies' anonymity will be preserved.
Research Approach
It's also quite important to determine the proper relationship between theory and
research (Bryman and Bell, 2007). One has to make a decision between an inductive
and a deductive research approach.
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In the deductive approach, one starts by formulating hypotheses which are then tested
against empirical scrutiny. The outcome is then used to either confirm or reject the
initial hypothesis. On the other hand, the inductive approach starts with the empirical
findings which are then analyzed and explained using theory. In other word, it can be
said to be a choice between theory before research or research before observations
(Ghauri and Grønhaug, 2005).
In this study, I chose to employ an inductive research approach. I will start by
conducting interviews and looking at internal documentation on the various types of
franchising agreements. I will then analyze those findings and link them to existing
theory.
Validity and Reliability
Important in any research project, academic or non-academic, is to make sure that
whatever conclusions are drawn from the study can be considered to be a reflection of
the data examined. In evaluating research, two separate measurements are usually
used: reliability and validity.
Reliability is normally concerned with whether the findings can accurately be replicated
by other researcher in similar cases (Bryman & Bell, 2007). One has to be very careful
when using interviews as a method for collecting data because the interviewer and
interviewee come from different backgrounds and don't necessarily see things the same
way which could lead to misunderstandings. The advantage of semi-structured
interviews is that they allow the interviewer to ask clarifying questions to make sure that
the interviewee and the interviewer both understand each other. By asking for clarifying
examples and by having the interviewee review my interview notes, I will minimize the
chance that our different educational backgrounds and experiences could lead to
misunderstandings. In qualitative research strategies, there is always a risk that data or
information is either misinterpreted or not understood correctly by either the interviewee
or the interviewer. The fact that the source of information is individuals will always
suggest that there is a concern in regards to reliability. However, I believe that through
my understanding of the sources of reliability issues and the precautious actions I will
take to minimize them, this study will not give rise to any considerable levels of
reliability related problems.
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The second aspect of the quality of research is validity. In its general form, validity is
concerned with the outcome and conclusions of the study (Bryman & Bell, 2007). There
are many different aspects to validity, not all of which apply to qualitative studies. Over
the next few paragraphs, I will account for those argued to be the most applicable to a
qualitative study (Bryman & Bell, 2007).
Starting with internal validity, it is the form of validity that is concerned with the
causality between two identified factors. If the conclusion is drawn that x causes y,
internal validity would be the measure that captures the flaw if that would not be the
case (Bryman & Bell, 2007). Thus, internal validity is concerned with whether a
conclusion derived from a causal relationship between different variables can be said to
hold water. The second type of validity that applies to my study is the external validity.
It deals with whether a study’s findings can be generalized, i.e. are the result and
conclusions coming out of the study relevant and applicable to a greater context or not
(Yin, 2003).
It is only after conducting my interviews and entering the phase of analyzing the data
that internal validity comes into play. To what extent can I be certain that what I
interpret as a conclusion coming from quote x really is an effect or a factor? To avoid
this as much as possible, cross checking and getting the data as well as the conclusion
verified is one tool to use. This can first of all be done with the interviewees during
follow up sessions as well as with my supervisor. Part of my agreement with my
interviewees was that I would send to them every part of my thesis that concerned
them (empirical findings, analysis, conclusion, etc.) so that they could read it and make
sure that every word written was accurate therefore this should help with ensure the
total accuracy of my reporting.
By verifying my data and conclusions with the interviewees in follow-up interview
sessions, I will be given the opportunity to make sure that I haven’t missed something
just due to the fact that the interviewee only answered the actual questions I asked.
Therefore, asking clarifying follow-up questions of more open character should limit this
potential pitfall. By verifying my reasoning in regards to a particular conclusion with my
supervisor, I can also ensure that I haven't neglected a factor or underestimated the
impact of another factor, which in turn would affect the internal validity of my study.
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External validity, on the other hand, deals with whether a study’s findings can be
generalized, i.e. are the results and conclusions coming out of the study relevant and
applicable to a greater context or not. Neither single nor multiple-case studies are
generally expected to allow for statistical generalization (Yin, 1994). However, analytical
generalization (which is generalization from empirical observations to theory, rather than
to a population) should be possible using a multiple case study approach. That is why,
following advice from my thesis advisor, I chose to use a multiple-case study as my
research design.
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Empirical Findings
This section has two main objectives. The first is to give the reader a better overview of
how the information was gathered and how the data was handled. The second, and
main, objective of this section is to share the information that was provided by the
interviewees during the interviews in regards to the different franchising agreements
that are used by the company as well as the factors that lead to the use of each.
Source and Handling of the Data
Regarding the selection of the respondents, I mostly relied on my sponsor in each
company to provide me with a list of people who were involved (or who had been
involved) in the process of deciding which franchising agreement should be used for a
specific location. I knew that they had much better understanding of the roles of the
various persons in the company as well as knowledge of whom had occupied the role in
the past and that they would be able to provide me with a good list.
In total, 21 interviews were conducted with 14 respondents. Nine of the respondents
worked for FoodChain and the other five respondents worked for Art4Everyone. Five
interviewees may seem like a low number to put a company's franchising strategy on
paper but Art4Everyone is a small company and additional interviews would not have
added value as all of the people that were involved in the elaboration of the company's
franchising strategy or that are responsible for putting it in practice were interviewed.
The interviews lasted between 30 minutes and two hours and were conducted either in
person or over the phone. In additional to the interviews themselves, there were also a
few instances where I called one of the respondents for a 5 or 10 minutes conversation
to clarify something that had been mentioned by during an interview. In general, the
perspectives of the respondents within each company were very similar. I would say
that the only differences in terms of what the interviewees mentioned were that
sometimes an interviewee would forget to mention something that another interviewee
had mentioned. Once I brought-up these differences in follow-up interviews or in quick
conversations over the phone to clarify aspects that were mentioned, the respondents
always said that it was an aspect that they considered but that they had forgotten to
mention in the interviews. Hence, there were no actual discrepancies between what the
respondents within a company said, only oversights.
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Additionally, data came from internal documents that described the franchising process
and the types of franchising agreements used. FoodChain had official documentation on
each type of franchising agreement while the only documentation that Art4Everyone had
was the documents that they send to people who are considering opening an
Art4Everyone franchise.
The following sections on FoodChain and Art4Everyone's franchising strategies only
contain raw data which has been reorganized for the sake of coherence. The reasoning
of the respondents has been included but my reasoning and analysis are totally absent
as that is going to be covered in the discussion and analysis part. The information
gathered about FoodChain and Art4Everyone is described in separate sections for the
sake of clarity. These sections are divided in two subsections; the first describing the
types of franchising agreements that the company uses and the second listing and
briefly describing the factors that affected the choice of a specific franchising agreement
over another.
Franchising Strategies
FoodChain Franchising Strategy
Types of Franchising Agreements Used
FoodChain uses four main types of franchising agreements: the traditional franchising
model, business facility leases (BFL), joint venture model and development licenses.
They also use other models but I chose not to include them as they were very slight
variations of the above models due to country-specific regulations.
Traditional Franchising Model: The first type of franchising agreement is the traditional
franchising model. Under this agreement, the franchisee leases the land and the building
from FoodChain. The franchisee will generally acquire one (or more) restaurants.
Initially, the franchisee will pay a franchise fee which will give him the support of the
corporation and the right to use the company's business model. The franchisee then has
to pay rent each month, which is used by the corporation for its general and
administrative expenses as well as other costs of the system (such as research and
development). Franchisees also have to pay a marketing contribution which the
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corporation combines with other franchisees' marketing contributions which allows the
leveraging of the company's buying power to pay less and have a greater impact.
Business Facility Lease: The second type of franchising agreement used by the company
is the business facility lease (BFL). One of the differences with the traditional franchising
model is that in addition to the land and building, the franchisee also leases the
equipment, signs, seating and decor in the restaurant which leads to a greater rent. The
franchisee is typically given a conditional option to purchase the facilities and to convert
the BFL franchise to a conventional franchise. BFL's are typically 3 years in duration.
They can also be renewed but FoodChain's objective is to have option exercised by the
franchisee to convert the BFL into a conventional franchise. The advantage of the BFL
for the franchisee is that he doesn't have to provide additional capital for the restaurant,
nor does he have to provide capital for the yearly reinvestment. Indeed, the company
pays for additional equipment or improvements to the building during the BFL term and
the franchisee agrees to reimburse FoodChain once he exercises the option to convert
the BFL.
Joint Venture: The third type of franchising agreement used by FoodChain is the joint
venture model. Under the joint venture model, the company partners with a franchisee
to open or acquire restaurants. The percentage allocated to each party varies but
FoodChain generally owns a greater percentage of the restaurants than the franchisee.
A legal agreement will be created which will put conditions for the investments and the
management of the restaurants. A small joint venture board will be created with the
franchisee and a representative from the company. This board will review the financial
statements of the restaurant each month and have a formal review every three months.
After some time, the franchisee can buy FoodChain's share of the restaurants (or the
other way around). The way the restaurant is going to be valued once one of the
partners wants to buy the other out is already established from the start in terms of
which variables are going to be taken into account, though the actual amount is not
fixed. This type of franchising agreement is interesting for FoodChain because the
franchisee remains the face of the franchise while the company receive part of the
profits.
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Development License: The fourth type of franchisee agreement is the development
license (DL). Under this type of agreement, FoodChain generally grants a franchise to a
person for a specific country or market and relies on that person to develop the market.
The person does not have to operate every restaurant on his own; he has the right to
grant franchises within his territory. In exchange for giving the businessman the right
(and duty) to open a certain number of restaurants within a certain number of years as
well as the right to use FoodChain's system and intellectual property, FoodChain
receives royalties. The company gets to collect royalties and increase revenues without
any investment. There is a DL business review conducted every two years which covers
the performance of the DL's entire organization. The objective of the review is to
determine whether the DL can be renewed, to make sure that the brand and business
initiative are aligned and to determine if the holder of the DL will be allowed to open
additional restaurants. The DL is evaluated upon 7 criteria: operational standards,
customer satisfaction, restaurant development and reinvestment, financial, people and
organizational development, sales and market share and the involvement of the
development licensee. Development licenses are fairly uncommon. FoodChain has only
granted one development license.
Factors that Affect the Franchising Agreement Used
The type of franchising agreement that the company decides to use depend on several
factors: the growth that is anticipated by the company, the proportion of outlets that
should be franchised, the number of qualified applicants available, financial
considerations, portfolio optimization, ownership preference and special circumstances.
Growth Anticipated by the Company
First, what may be the most important discussion that FoodChain executives have during
the strategic planning process relates to what type of growth the company anticipates
over the next five years and what sort of market the company operates in. The
franchising model used in a market where the company wishes to grow aggressively
could be quite different from the model used in a market in which the company
anticipates slow, organic growth.
Part of the reason behind this is the importance of the human capital part of expansion.
No matter what model the company wishes to use, having the right partner is
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paramount. Not only does training a franchisee take time, the process is also very
selective; not everyone has the potential to become a good franchisee. A strong
candidate will demonstrate that he has the right leadership and team work
competencies and that he is an entrepreneur at heart who is able to function
autonomously. Yet, he also has to be able to live within the limits of the system. He will
also have the financial means to purchase a franchise and the willingness to participate
actively in the day-to-day of the business as required by the organization. Ideally, the
candidate will also have experience managing personnel and delegating, as some stores
are open 24 hours a day, seven days a week therefore he won't always be in the store.
The training process lasts between 12 and 18 months depending on how fast the
candidate is able to go through it. No guarantees are offered to the candidate and the
company has the option to end the training program at any time without providing any
compensation. FoodChain is even more demanding when looking for joint venture
partners and development license holders.
Keeping the above into account, the growth that the company wishes to achieve and the
market in which it operates will definitely impact which franchising agreement is chosen
by the organization. If the organization operates in a mature market where growth is
somewhat limited then using the traditional franchising model along with the BFL
franchising model should support the growth well enough. However, if the organization
is looking at developing aggressively in a country where it already has a presence then
perhaps a joint venture approach would work better, given that a partnership with an
existing operator could be established and growth could be supported by the corporation
financially. Again, if the corporation is developing a new country, and pending the speed
and level at which it wishes to grow and the complexity of growing in a given area (in
terms of government involvement, for example) then it might make sense to consider a
development license. Development licenses are an interesting approach to fast growth
as they allow the organization to leverage somebody else's capital.
Proportion of Outlets that Should be Franchised
Another important discussion that FoodChain executives have during the strategic
planning process relates to the proportion of their outlets that should be owned by
franchisees. This is an important consideration as the choice isn't only between the
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different types of franchising agreements; there is always a possibility that the company
could choose to own the store. The answer that FoodChain executives came to is that
they believe a model that has both franchises and company-owned restaurants has
merits.
On one hand, company-owned restaurants enable the "people pump", the production of
people that will eventually become supervisory personnel in the system. Having the
ability to develop strong operations consultants and business consultants that
understand the business carefully is paramount in being able to guide new franchisees.
Seeing as these workers have experience in company-owned restaurants who follow
best practices, they will have an easier time evaluating franchisees' performance and
giving them advice. If the company didn't own any restaurant then supervisory
personnel would have to be found outside of the firm. The supervisory personnel would
also start from scratch as they wouldn't know how a FoodChain outlet is expected to be
run. Having never done it before, the supervisory personnel would have much less
credibility, thus much less impact on franchisees. It's also easier from a testing stand
point where the company can assume its own risk in a very controlled environment.
Also, having company-owned restaurants gives the organization credibility in the
franchisees' eyes as the decisions that are made not only affect it as a corporation; they
also affect the organization on the restaurant side of the business. Since the royalty paid
by franchisees depends on revenues alone, it might be advantageous for a firm to get
franchisees to implement programs or innovations that are good for revenues even if
they have the potential to lead to reduced profitability. By maintaining a certain
proportion of company stores, the corporation can show franchisees that it is not asking
them to implement innovations which it is not willing to implement itself. This results in
a greater buy-in from franchisees and a stronger company overall where everyone
pushes in the same direction.
Finally, owning restaurants also allows the company to leverage opportunities for future
growth if it makes sense in a given geography without having to necessarily wait for the
right franchisee candidate to come along.
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With that said, only having company-owned stores may not necessarily be the best
utilization of corporate funds. The main advantage of franchises is that they allow
FoodChain to leverage others' investments and still collect royalties and create a real
estate margin by collecting rent. It's one way of getting greater returns as a percentage
of your overall investment. It is also a necessity to have franchisees as you will be better
represented by people that live in the same communities in which they operate as these
people are the closest to the market. They have a better understanding of what's
important to their customers.
Hence, both company-owned restaurants and franchised restaurants are important to
the success of FoodChain. Depending on the desired proportion of franchised outlets, an
existing store owned by the company could be sold to another franchisee if the strategic
plan called for less company-owned restaurants and more franchises, just as an existing
franchise being sold by a franchisee could be repurchased by the company if the
strategic plan called for a greater proportion of company-owned stores.
Availability of Qualified Applicants
Another element that needs to be taken into account is the status of the company's
pipeline of registered applicants. If a franchisee is retiring and the company's pipeline is
empty then the company's only options are to either buy the restaurant, or sell it to an
existing franchisee. This highlights the importance of having an ongoing dialogue with
existing franchisees. Any organization who wants to ensure a smooth transition to
qualified candidates should make sure it has a good idea of what level of turnover it can
expect within its franchisee community. For instance, if the organization knows that over
the next three years, five or six of its franchisees are going to retire then it will need
franchisees to take over those businesses. Training franchisees takes time and finding
the right candidate is paramount therefore the company should always make sure it has
candidates in the pipeline, ready to take over those businesses so that the company
doesn't have to. I should add that a lot of emphasis was placed by the interviewees on
the selectivity of the recruitment process and how important it is to make sure that
restaurants are run by qualified people with the right attitude. The company always
makes sure that every time it sells a restaurant it's given to the franchisee who is the
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strongest. It could make sense to give it to a new franchisee if he is stronger than the
one that is on-site.
Financial Considerations and Portfolio Optimization
Another very important factor that affects what franchising agreement is going to be
used are the financials. Some of the models are more profitable than others. Some
models are also more capital-intensive than others from the company or the franchisee's
point of view. For example, a BFL is generally less profitable for the company as the
company owns the assets and has to make the capital contribution towards
reinvestments each year. The traditional franchising model from that standpoint makes
sense as the organization collect royalties on the business while the franchisee owns the
assets and is the one who has to make the capital contribution each year. The
organization also collects a "career rental margin" which is the difference between the
rent that the organization collects and the rent the organization pays out, minus the
carrying cost of that investment (i.e. interest and amortization) so that is an important
consideration as well.
The organization is always looking at increasing the value for the shareholders and
externally analysts look at the notion of free cash flow to value the future earnings of
the company. As such, corporate locations are more capital intensive than franchised
locations as you need to invest in them so for corporate locations free cash flow is the
operating cash flow minus the general and administrative expenses required to support
those locations minus the average reinvestment.
Obviously, that drives the need to have high-performance company-owned restaurants
otherwise the organization could find itself in a situation where it has negative free cash
flow from some of its corporate locations. This triggers the notion of portfolio
optimization. FoodChain quintiles its portfolio and over time tries to dispose of its fifth
quintile and purchase top quintile restaurants. Hence, the performance of a restaurant
being sold by an existing franchisee could impact the franchising model used as well as
the likelihood of the restaurant being repurchased by FoodChain or sold to another
franchisee.
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Another element related to portfolio optimization is that as part of the franchising
agreement, FoodChain has the ability to exercise first right of refusal on any outlet that
goes on sale. If the franchisee decides that he wants to sell his stores then the company
has approve the buyer. The company has to right to buy any restaurant that becomes
available and transform it into a corporate restaurant.
Ownership Preference
Another factor that could affect the franchising model used is the fact that from a
restaurant ownership standpoint, its FoodChain's preference that all their franchisees
own more than one restaurant. There are several reasons for this preference. First,
FoodChain wants stability for its franchisees. The notion of having more than one
restaurant gives the franchisee the opportunity to "hedge his bets". If a franchisee's only
restaurant were to face a temporary challenge such as a road closure then the situation
would be a lot more difficult for him to bear than if he operated multiple outlets. Multiple
locations also bring operational efficiencies. For example, the franchisee's salary and as
well as general and administrative experiences can be divided amongst multiple
restaurants instead of only one. This could be important for a franchisee, especially in a
situation where margins were to become smaller due to circumstances out of his control
such as an increase in the costs of global commodities. Having multiple locations allows
the franchisee to hedge his bets and to maintain a decent income even if margins or
sales become smaller for a reason or another.
Having more than one restaurants also makes it easier for the franchisee to expand for
several reasons. First, having more than one restaurant builds equity much faster than
having only one restaurant. It also generates borrowing capacity for the franchisee
which gives him the opportunity to expand. If a franchisee only owned one restaurant
and then came an opportunity to buy 5 or 6 restaurants the franchisee may simply not
have the financial capabilities to buy these locations. The ramp-up would also be much
more difficult going from 1 restaurant to 6 than from 2 or 3 to 6, as the franchisee
would already have experience dividing his attention amongst multiple restaurants
therefore he would already know how to ensure that the quality of the offering remains
high despite the fact that he can't be everywhere at the same time.
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Once a franchisee is brought into the system, it's the company's preference to start with
a single restaurant and then in time grow to multiple locations. The transition is much
easier for the franchisee this way than when the person has to absorb several
restaurants at once, which is far more challenging. Of course, there are circumstances
under which the company doesn't have a choice. For example, if the original owner in a
remote market has 5 restaurants and wants to retire then obviously it's not possible to
sell them one at a time, so the company won't have a choice and it will need to
transition the 5 restaurants all at once. In these circumstances, the company will
support the transition more aggressively with its field service team to ensure a smooth
transition.
In terms of whether a conventional franchise is going to be awarded to an existing
franchisee or to a new franchisee, there are several factors that affect this decision. First
is the future growth that the company expects in the area. If the company believes that
it's going to be their only new restaurant in the area for a long time then in this case
they would prefer to sell it to an existing franchisee, as it would probably be a new
franchisee's sole restaurant otherwise. The exception to this would be if the company
believes that the existing franchisee is at maximum capacity, so to speak. On the other
hand, if the market has a lot of potential future growth then it could make sense to
introduce a new franchisee in the area knowing that in time the market will grow
beyond one restaurant. What the company tries to do is avoid long-term single
ownership as it may restrict the ability to ensure financial stability for the franchisee.
Special Circumstances
There are also a few special circumstances which will lead the company to use a specific
model. First, in a situation where the company isn't certain if it will be able to keep
operating the restaurant beyond the duration of the building lease, BFLs are often going
to be used because they make more sense from everyone's standpoint seeing as
otherwise the franchisee would have to purchase brand new equipment, seating, signs
and decor that would only be used for the remainder of the lease. If the lease is almost
up and the company isn't certain that it's going to be possible to renew it then BFLs are
typically the preferred franchise model.
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BFLs can also be used in situations where the financial means of a good franchisee and
somewhat limited but the company would like to entrust him with more restaurants. For
example, if the company wanted to sell 3 restaurants but the person only had the
capital for two then the company could sell him 2 restaurants using the traditional
franchising model and one using the BFL franchising model. The franchisee would then
have the option of converting the BFL to a conventional franchise at some point in the
future.
Another set of special circumstances is when a restaurant is not very profitable but there
is a clause to the rental contract which states that the company has to keep operating
the restaurant. In a situation such as this one it can be better to use a BFL than to use
internal resources to run the restaurant.
The joint venture model is generally used in existing markets who have chosen to
accelerate their growth and who have good candidates with the money for two or three
restaurants but not enough to purchase all the restaurants that the company would like
to sell. The company will then co-invest with the franchisee who will later have the
option of buying out the company.
Art4Everyone Franchising Strategy
Types of Franchising Agreements Used
Art4Everyone uses three main types of franchising agreements: junior franchises,
master franchises and joint-ventures.
Junior Franchise: The first type of franchising agreement is the junior franchise model
which is the way Art4Everyone calls the traditional franchising model. Franchisees that
use this type of franchising agreement may own one or more outlets. Initially, the
franchisee will pay a franchise fee which will give him the support of the corporation and
the right to use the company's business model. He also pays for the inventory upfront
and then pays to replace the inventory once it has been sold. The franchisee then has to
pay rent each month which pays for the general and administrative expenses of the
corporation as well as other costs of the system. The company makes money by selling
art to the franchisee as well as getting a percentage of realized sales at the end of the
month.
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Master Franchise: Master franchises are granted the right to open a certain number of
franchises within a given area. The master franchisee also has the right (and is actually
expected by the company) to sub-franchise. He has exclusive rights to this area as long
as he opens a certain number of franchises during a certain period. Master franchisees
have the advantage of receiving royalties from online sales. However, they are also
more expensive than junior franchises. Also, a franchise fee must be paid for each
franchise opened by the master franchisee (or one of his franchisees). While the
company does grant master franchises, the rights that come with the master franchise
are only officially granted when the franchisee has proven that he can meet
commitments. The franchisee has to achieve certain sales targets and open a certain
number of outlets before actually getting exclusive rights to the area as well as getting
the right to sub-franchise. Once he has achieved the targets set by the company in
terms of sales and in terms of number of outlets, he has to pay the rest of the franchise
fees and then every aspect of the master franchise is unlocked. This way, the company
can make sure that the franchisee really understands how the business has to be run
before being given the rights of a master franchisee. Master franchises are a good way
for the company to achieve a high level of growth at low risk and with little supervision
(which is essential for a small company which doesn't have the supervisory system in
place to micromanage individual franchises all over the world). Granting master
franchises has the added benefit of reassuring investors by showing them that strong
growth is going to be achieved over the next few years because they know that the
franchisees are going to fulfill their part of the contract since they don't want to lose the
master franchise license.
Joint Venture: The third type of franchising agreement used by Art4Everyone is the joint
venture model. Under the joint venture model, the company partners with the
franchisee (existing or to be) to open or acquire restaurants. The percentage allocated
to each party varies but Art4Everyone generally owns a greater percentage of the
restaurants than the franchisee. The way the restaurant is going to be valued once one
of the partners wants to buy the other out is already established from the start in terms
of which variables are going to be taken into account, though the actual amount is not
fixed.
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Factors that Affect the Franchising Agreement Used
Knowledge of the Market and Market Risk
One of the main factors considered by Art4Everyone when determining the type of
franchise agreement used is how knowledgeable the company is about the market. If
the company knows a lot about a particular market then there is less of a risk of the
company undervaluing how much a master franchise in that market is worth. In cases
where the company is not able to evaluate the market's potential, the company
generally prefers to sell a few junior franchises. After the first franchises are built, it's
much easier for the company to understand how much potential there is in a particular
market seeing as the company will be able to compare the sales of the franchises in that
region with sales in other regions. The company can then set a fair price to the master
franchise.
An aspect that is strongly linked to the knowledge of the market is the market risk.
While the company prefers owning stores rather than selling franchises in markets
where there is a low amount of risk, it is difficult to know how much risk there is in a
given market without actually having stores there. The error margin is razor thin for a
new company with little capital so every company-owned outlet that it opens has to be a
success. One way to enhance Art4Everyone's knowledge of a given market is to grant
junior franchises there to see how much success they have. Once the company has a
good idea of the income that it can expect from owning stores there, it then becomes
easier for the company to make the decision to invest in company-owned stores in that
country.
Financial Considerations
Financial considerations also affect the type of agreement used. For example, if
investors are willing to put in a lot of money to jointly own a store in a good market
then it could be interesting for Art4Everyone to set up a joint venture with the investors
as the company would get a good value for the store. Obviously, the availability of
financial capital for Art4Everyone has a huge impact on whether the company can afford
to own a store or if it has to franchise it instead.
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Availability of Qualified Personnel
Another aspect is the availability of qualified personnel. In France, a country where
Art4Everyone has been operating for a few years now, there is a pool of qualified
personnel which could potentially run art galleries therefore the company does have the
option to open company-owned stores there. However, in countries where it doesn't
have stores or in countries where it only has franchised stores, it is quite difficult to
open company-owned stores as the company has no qualified personnel there hence the
only option is to sell franchises. That being said, Art4Everyone is not that selective in
terms of who is allowed to become a franchisee. The main criterion used to measure
someone's worthiness is the amount of money he is willing to put in play. If he has
enough money to pay for the franchise then that is sufficient for the company.
Ownership Preference
Another aspect is the fact that the company prefers selling master franchises instead of
junior franchises, as master franchises are much more independent. The fact that
Art4Everyone is still fairly small and does not have a large number of supervisory
personnel makes it difficult to supervise a large number of individual franchises located
in many countries. Hence, it's much easier from a performance management standpoint
to support a few master franchises than it is to support many junior franchises. This
explains why the company has a preference for selling master franchises. Master
franchises are much more independent. They can solve small problems on their own and
discuss large issues with the company. Junior franchises, on the other hand, are more
likely to require constant attention for small issues that are store specific and that may
not be worth the company's time. The size of the company does not presently allow it to
micro-manage a large number of individual franchisees.
Proportion of Outlets that Should be Franchised
Another fairly important aspect is the proportion of outlets that should be franchised
according to the management team. The company's current objective is to franchise
about half of its outlets and own the other half. According to the person in charge of the
franchising in North America for Art4Everyone, company-owned stores are generally
more profitable than franchises in this industry, which explains why the objective is to
own at least half (50%) of the outlets. The 50% figure is a minimum; it allows the
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company to diversify its portfolio. If the stores aren't doing well in a certain region then
they may be doing better in other regions. It also allows the company to retain a certain
amount of control over the brand and on the franchisees in order to maintain its brand
image. The person in charge of franchising claims that in an ideal world, every store
would be company-owned (giving them perfect control and greater revenues).
The reason why the company doesn't aim for 100% ownership is that the time-to-
market would be negatively affected. The company doesn't want competitors to copy its
business model so it needs to grow as fast as possible for brand recognition and to
acquire prime locations. However, it doesn't have the capital needed to grow fast
enough. Plus, there is an advantage that comes with local franchisees: they bear the
financial risk, they have experience doing business in the country, they speak the
language and they have the network.
The contracts between the company and its franchisees are renewed automatically
every seven years, as long as the franchisees meet the objectives that have been set
(number of outlets, total sales, etc.). If they don't meet those targets then Art4Everyone
has the option of repurchasing the franchise at a predefined price (usually a multiple of
the franchise' EBITDA). The interviewee did mention that they would be looking at this
option every time a contract was up for renewal, if the objectives hadn't been met.
Analysis and Discussion
In this section, I will analyze and discuss the information that was gathered in the
interviews. The analysis is divided in two sections. The first section looks at the types of
franchising agreements that were identified in interviews and compares those with the
four types of franchising agreements that are most commonly identified by academics.
The second section looks factors that are taken into consideration by the two companies
when trying to decide which type of franchising agreement should be used. The second
section is divided in two subsections; one for FoodChain and one for Art4Everyone.
The analysis was done in the following manner. In the first section, the franchising
agreements that were identified by interviewees were cross-referenced against the
franchising agreements that were generally mentioned in research and by franchising
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associations. In the second section, factors that were identified by interviewees were
acknowledged and links were made between the interviewees' explanations and various
theoretical perspectives that were explained in the literature review.
Analysis and Discussion
Types of Franchising Agreements
The first thing that stands out following the interviews that were conducted at
FoodChain and Art4Everyone is that there are discrepancies when we compare the
franchising agreements that are mentioned in the literature and the ones that are
actually used by corporations.
First, academics seem to make distinctions that are not necessarily made at the
corporate level. For example, academics made a distinction between single-unit
franchising and multi-unit franchising but actually both fell under the same label for
FoodChain (traditional franchising model) and Art4Everyone (junior franchises).
Franchisees kept the same label no matter the number of outlets under management.
The distinction that academics made between single-unit and multi-unit franchising did
not exist for FoodChain, nor for Art4Everyone. That being said, it should be noted that
FoodChain did make a slight difference between the two in the sense that the company
preferred multi-franchise ownership to single-franchise ownership. For example, while
franchisees are generally given responsibility for a single store when they join
FoodChain, there is a natural transition which takes place towards multi-unit ownership
because strong franchisees make for a strong company.
Also, FoodChain and Art4Everyone did not differentiate between development licenses
and master franchises. FoodChain used the label development license but the holder of
the license also had the right to grant franchises which would have made it a master
franchise according to academics, as holders of development licenses do not have the
right to grant franchises. Similarly, Art4Everyone did not make a difference between
development licenses and master franchises, as they only sold master franchises (with
the right to sell franchises). They did not use development licenses at all.
Also, the interviews that were conducted with people from FoodChain and from
Art4Everyone highlighted some types of franchising agreements that were generally not
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mentioned by academics. Looking at the franchising agreements that were mentioned
by FoodChain, Business Facility Leases (BFL) and Joint Ventures were never mentioned
in the literature. The franchising concepts in the literature all implied full ownership by
the franchisee. In reality, I found that FoodChain sometimes co-owned franchises (Joint
Venture) and owned outlets that were under management by franchisee (BFL's). As for
Art4Everyone, they used joint ventures to some extent. Neither BFL's nor Joint Ventures
were found in franchising literature.
The following chart summarizes this thesis' findings regarding the types of franchising
agreements used by companies versus those that are mentioned by academics:
It seems that franchising literature has mostly considered the size (one or more
franchises) and rights (exclusive territory, right to grant franchises) associated with
franchising agreements. However, while Art4Everyone and FoodChain used these
agreements, they also used franchising agreements that were not described in the
franchising literature. The types of franchising agreements used by Art4Everyone and
FoodChain also looked at the financing behind the franchising agreement and whether
part or all of the franchised outlet would be financed and owned by the company.
Franchising Agreements Used By FoodChain (FC) and By
Art4Everyone (A4E)
Franchising Agreements Mentioned By Academics
Traditional Franchising Model (FC) / Junior Franchises (A4E)
Single-Unit Franchisee
Multi-Unit Franchisee
Master Franchise (A4E) / Development License (FC)
Master Franchise
Development License
Joint Ventures (FC and A4E) Not in Franchising Literature
Business Franchise License (BFL’s) (FC)
Not in Franchising Literature
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Factors that Affect the Organizational Form of the Outlet
Following the interviews with FoodChain and Art4Everyone executives, a number of
factors that affect the type of franchising agreement used were identified: the growth
anticipated by the company, the proportion of outlets that should be franchised, the
expected level of franchisee turnover, financial considerations, portfolio optimization,
ownership preference, availability of qualified personnel, market knowledge, market risk
and special circumstances. Many factors held importance for both FoodChain and
Art4Everyone executives, but there were also factors which were unique to one of the
two companies. Seeing as the factors did not always have the same impact on the type
of franchising agreement that be used by the company, I decided to consider FoodChain
and Art4Everyone separately as doing otherwise would have made for a very messy
model.
It should be noted that the various franchising agreements were not only compared
amongst themselves, they were also compared against the possibility of keeping the
outlet as a company-owned store. It was important to compare the various franchising
agreements with the possibility of the store being company-owned, as owning a certain
number of outlets is an important part of both companies' strategy. Excluding company-
owned stores would have meant ignoring one of the key "solutions" that the companies
had found to certain market factors. Hence, the analysis of each company is divided in
two parts. First, we will look at criteria that can have an effect as to whether the outlet
is going to be company-owned or if it is going to be franchised. Then, the factors that
affect the company's decision as to which franchising agreement it will use are going to
be discussed.
Analysis of FoodChain's Franchising Strategy
Factors that Lead Outlets to Become Company-Owned
The three main factors that lead FoodChain to choose company ownership over
franchisee ownership are the proportion of outlets that the company believes should be
franchised, portfolio optimization (which is when a company simultaneously sells a
company-owned store and repurchases a more profitable franchise, hereby replacing the
store it just sold) and financial considerations.
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First, the desired proportion of company-owned outlets is one of the main factors
that can lead to company ownership. For example, if the company's strategic plan states
that the number of company-owned locations is too low then this could lead to
profitable franchises that are on sale being repurchased by the company instead of
being sold off to other franchisees. On the other hand, if the company's strategic plan
states that the company needs to increase its number of franchised locations then that
could lead to current company-owned locations being sold to franchisees or franchises
currently on sale by franchisees being resold to other franchisees.
One implication that comes from the idea that a company would target a certain
proportion of company-owned stores is that it means the company thinks it is better off
with both types of locations than with only one type. Academics call this the plural form
in franchising. The idea behind this concept is that a combination of organizational
arrangements may actually be better than the use only one organizational arrangement,
because those organizational arrangements may possess a synergism when used
simultaneously (Lewin-Solomons, 2000). There was a lot of support for this concept
during the interviews with FoodChain executives, as numerous benefits to having both
company-owned and franchised stores were mentioned. For example, a synergy that
was proposed by a FoodChain executive is that having company-owned stores gives the
company more credibility in the eyes of the franchisees as it show franchisees that the
company has "skin in the game", that it has something to lose. This way, it's much
easier for the company to convince franchisees to implement their programs or
innovations. By maintaining a certain proportion of company stores, the corporation can
show franchisees that it is not asking them to implement innovations which it is not
willing to implement itself (Lewin-Solomons, 2000). The result is a greater buy-in from
franchisees and a stronger company overall.
Another advantage of having a combination of company-owned and franchised stores
that was not mentioned in the franchising literature but that was mentioned by some of
the interviewees is that company-owned stores are a source of supervisory personnel
that can, after a few years, go up the corporate ladder and start supervising franchised
stores and giving advice to new franchisees.
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To summarize, FoodChain executives found that maintaining a certain proportion of
company-owned stores was important as it generates a greater buy-in from franchisees
and it's a source of qualified supervisory personnel. Should executives believe that more
company-owned locations are needed then this will definitely have an impact on
whether an outlet will be franchised or company-owned.
The second factor that stood out that could lead to a store becoming company-owned is
portfolio optimization. Portfolio optimization refers to the idea of selling not-so
profitable stores that are currently owned by the company and replacing them by stores
that are currently owned by franchisees and that are more profitable. This is particularly
interesting as it relates directly to the second prediction of resource scarcity theory,
which is that once economies of scale have been attained, franchisors will maintain
company ownership over new outlets and eventually repurchase all but the least
profitable franchised outlets (Oxenfeldt and Kelly, 1969). While it is true that FoodChain
quintiles its portfolio and tries to sell bottom-quintile outlets and replace them with top-
quintile outlets, that is still a far cry from what was proposed by Oxenfeldt and Kelly.
Oxenfeldt and Kelly believed that companies would stop franchising and start re-buying
the majority of their franchises. FoodChain is optimizing its portfolio by selling stores
that are less profitable and purchasing stores that are more profitable. The company is
not trying to own every single profitable store, it is simply trying to make sure that the
stores it owns are as profitable as possible. As one of the interviewees mentioned, the
company does not want to find itself in a situation where it has negative free cash flow
from some of its corporate locations
This also comes back to the concept of plural ownership in franchising and how it may
not make sense to repurchase every profitable franchise. The concept of the plural form
in franchising is in stark contrast with the second prediction of ownership redirection in
that it supports the idea of having both franchises and company-owned stores due to
synergies that can be derived from having both organizational forms.
Finally, the third factor that had a strong effect on whether an outlet would be owned by
the company or by a franchisee through one of the franchising models is financial
considerations (including availability of capital). For example, there are large
differences between company-owned outlets and the various franchising models in
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terms of how profitable and capital intensive they are to the company. For example, a
BFL is generally less profitable for the company as the company is owning the assets
and it has to make the capital contribution towards reinvestments each year. The
traditional franchising model from that standpoint makes sense as the organization
collect royalties on the business while the franchisee owns the assets and is the one
who has to make the capital contribution each year. Of course, the most capital-
intensive organizational form of all is company-owned outlets.
There is a strong link to be made between financial considerations and the first
prediction of resource scarcity which states that franchising is used as a way of
overcoming internal limitations to growth. The limitations to growth that are mentioned
in literature by Oxenfeldt and Kelly (1969) are labor and capital. FoodChain is a mature
company with a healthy level of cash on hand. Hence, an argument could be made that
it could definitely fund its own growth if it wished to. While that is a valid argument, an
aspect to consider is whether the company would want to do so. As was mentioned by
an interviewee, "it may not be the best utilization of corporate funds".
One of the issues that I have with the resource scarcity theory is that it begins with the
premise that franchising is used early in a firm's existence as a way to overcome
limitations to growth. Using the information that was provided by the interviewees, it
has become clear in my mind that franchising is not only used early in a firm's existence.
FoodChain is a prime example of this as it has been around for over 60 years and nearly
80% of its outlets are franchised. I would also argue that franchising is not necessarily
used to overcome limitations to growth (lack of capital and needed managerial
expertise). Again, FoodChain is a prime example with close to $2.5B of cash and cash
equivalents on hand, according to its latest balance sheet. The company could easily
repurchase hundreds if not thousands of outlets if it wished to.
I would argue that franchising is also used later on by mature firms because while they
may have enough capital to keep growing without franchising, it's more profitable for
them to use this capital in other ways therefore they choose to franchise instead.
Oxenfeldt and Kelly believe that over time, successful franchisors will overcome internal
limitations in terms of capital and in terms of the time it takes to train managers and
repurchase the most profitable franchised outlets. While it's understandable why a
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company could have interest in purchasing a profitable outlet, one could wonder why a
franchisee could wish to sell a profitable venture. Oxenfeldt and Kelly explain that there
are several factors that could lead a franchisee to sell the franchise back to the
franchisor. Using the life-cycle model, they explain that the franchisee's opportunities
(along with his goals and capabilities) change as time progresses and that such changes
ultimately lead him to sell the franchise. For example, "as the franchisee makes money
during the growth and prosperity stages, his opportunities for investment elsewhere
expand (if for no other reason that his increased resources)" (Oxenfeldt and Kelly,
1969). They add that "the more attractive other investment opportunities are and the
more likely the franchisee will be to sell out".
This is where, I believe, there is a slight contradiction in what Oxenfeldt and Kelly say.
They believe that other, more attractive opportunities are going to present themselves
to the franchisee that could lead him to try and sell the franchise, but they don't
mention how more attractive opportunities could also present themselves to the
franchisor which could make him want to use the capital in other ways. It is true that as
times goes by, opportunities are going to present themselves to the franchisee which
could make him want to sell the franchise back to the franchisor but that the same could
be said for the franchisor: more attractive opportunities are going to present
themselves. If the franchisor were to buy back every franchise then he would miss out
on a lot of other opportunities. As one of my interviewees at FoodChain said, "[...] only
having company-owned stores may not necessarily be the best utilization of corporate
funds. The main advantage of franchises is that they allow FoodChain to leverage
others' investments and still collect royalties and create a real estate margin by
collecting rent." As such, corporate locations are more capital intensive than franchise
locations for the corporation, seeing as it needs to pay for the general and
administrative expenses as well as for the yearly reinvestment. Having franchises allows
the company to leverage somebody else's capital and to use their own capital for other,
more rewarding uses. For example, the company could have to make a decision
between purchasing a franchise or building 3 or 4 restaurants in prime locations which it
can then sell to franchisees and collect additional income from.
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That is why I posit that some of the reasons that lead firms to franchise early on in their
existence do not totally go away, particularly capital scarcity. Capital is always scarce, as
there is always an opportunity cost. Firms don't have the capital to do everything at
once, so they have to choose the best way to use their capital. One of the main reasons
why a type of franchising agreement is going to be chosen over another is how
profitable a venture is for them, and how capital intensive it is. Companies will choose
the type of franchising agreement that will be the most profitable relative to how capital
intensive it is. Hence, financial considerations play a large role in terms of whether an
outlet is going to be franchised or if it is going to be company-owned. Only having
company-owned stores may not be the best way to maximize profits and cash flow over
the long term. This was supported by the comments made by one of the senior
executives at FoodChain, who explained that corporate locations were much more
capital intensive than franchised locations as they generate general and administrative
expenses and necessitate yearly reinvestments. The following graph shows the
conditions that must be met for FoodChain to make the decision to build a company-
owned outlet.
Company wishes to build another restaurant
Company will repuchase or build company-owned outlet if
Financial Considerations: Best Return on Company’s capital
Proportion of outlets that should be company-owned is greater
than current proportion
Portfolio Optimization: Franchise up for sale by franchisee is more
profitable than outlet currently in company’s portfolio
Company will repurchase or build franchised outlet if
Financial Considerations: There are other, better ways to use the
capital than to own the outlet
Proportion of outlets that should be company-owned is smaller
than current proportion
Portfolio Optimization: Franchise up for sale by franchisee is less
profitable than outlet currently in company’s portfolio
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Factors that Lead Companies to Choose One Franchising Agreement over the Others
Once FoodChain has chosen to franchise, a few factors affect which type of franchising
agreement is going to be used: the growth that is anticipated by the company,
availability of qualified applicants, ownership preference and special circumstances.
First, one of the main factors that affect the type of franchising agreement used is the
growth that is anticipated by the company over the next few years in that market.
For example, the argument that was made by FoodChain executives was that if a lot of
growth is anticipated in the coming years in an underdeveloped market then a
development license could make a lot of sense as it allows the company to leverage
someone else's capital for growth and conditions can be placed on the agreement as to
how many stores have to be opened every year. If, on the other hand, the company is
evolving in a mature market and has plans for slow and steady growth then "a mixture
of traditional franchising model and BFLs should suffice". The graph below shows the
types of franchising agreements that are going to be favored according to the type of
market and expected growth of the market itself. It should be noted that development
licenses are only used in new markets where a lot of growth is anticipated. Development
licenses are not going to be part of the analysis going forward as high growth is the only
factor that could lead to the use of a development license.
Another aspect that affects the type of franchising agreement used is the availability
of qualified applicants (including expected franchisee turnover). As was
mentioned earlier, one of the aspects that affect the type of franchising agreement that
Growth anticipated by the company
Existing market with low or medium growth
Traditional Franchising Model (Single-franchise)
Traditional Franchising Model (Multi-franchise)
Joint Venture
Business Franchise License (BFL)
New market with high expectations of growth
Development License
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is going to be used is the growth that is expected over the next few years. This, in turn,
affects the number of franchisees that are going to be needed to own these locations.
The number of franchisees that are going to be needed in the following years is a
combination of three factors: expected franchisee turnover, anticipated growth for the
next few years and desired proportion of franchised outlets. The company has to make
sure that the pipeline of registered applicants is able to handle the company's needs in
terms of franchisees because otherwise it may be forced to either take over the
restaurant or overload certain franchisees. The concept of the plural form in franchising
supports the idea of having both franchises and company-owned stores as it is possible
to derive synergies form having both organizational forms (Lewin-Solomons, 2000).
If the pipeline of qualified applicants is empty then this is going to have ramifications on
the type of franchising agreement used. If you have enough qualified applicants then
you can sell them individual franchises. On the other hand, if you don't have enough
qualified applicants then you have to find ways to build the stores without having access
to franchisees' capital. There are a few ways to do this: sell the franchise to an existing
franchisee, invest with a current franchisee who doesn't have enough money on his own
to purchase the outlet (joint venture), or simply own the restaurant but get a franchisee
to run it, using a business facility lease (BFL). Once the three years are over, he will
hopefully have accumulated enough equity to convert the BFL into a conventional
franchise.
Also, the company's ownership preference affects the type of franchising agreement
used. FoodChain's preference is that all of their franchisees own more than one
Availability of Qualified Applicants
Few qualified applicants
Joint Venture
Business Franchise License (BFL)
Traditional Franchising Model (Multi-franchise)
Many qualified applicants Traditional Franchising
Model (Single-franchise)
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restaurant. One of the reasons for this is that it increases the franchisees' financial
stability. Multiple locations also bring operational efficiencies and make it easier for the
franchisee to expand further both in terms of capital and in terms of management
capabilities (because he has built more equity and because he is already used to
managing multiple locations).
FoodChain's first choice will be to grant the franchise to an existing, high-performing
franchisee. If none of the franchisees operating in the same region as the outlet is able
to purchase it due to financial constraints then the company could look at using a
business franchise license (BFL) or a joint venture in order to make sure that the
franchise goes to an experienced, talented franchisee. Should none of these options be
feasible because the franchisees are all at maximum capacity, unwilling or unable to
take on more restaurants then the company will look at granting the franchise to a
qualified candidate.
Agency theory proponents would add that having franchisees own multiple restaurants
makes them less likely to shirk as owning multiple stores within the same geographical
area means that a store's bad performance will affect the franchisee's other stores as
well. The idea is that franchisees enjoy the full benefit of their shirking but share the
costs with other franchisees (Caves and Murphy, 1976). Having more restaurants in the
area means that the franchisee who does the shirking will be even more affected.
Finally, there are also some special circumstances which can have a large incidence
on the type of franchising agreement used. For example, BFLs are often going to be
Ownership Preference - Multi-
franchise ownership
Traditional Franchising Model (Multi-franchise)
If franchisee can’t afford full purchase
Business Franchise License (BFL)
Joint Venture
No nearby franchisee able or willing
Traditional Franchising Model (Single-franchise)
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used in situations where the company isn't certain if it will be able to keep operating the
restaurant beyond the duration of the building lease. Using a BFL makes more sense
from everyone's standpoint seeing as otherwise the franchisee would have to purchase
brand new equipment, seating, signs and decor that would only be used for the
remainder of the lease. If the lease is almost up and the company isn't certain that it's
going to be possible to renew it then BFLs are typically the preferred franchise model.
Otherwise, BFL's and joint ventures are also used in situations where the financial
means of a good franchisee are somewhat limited but the company would like to entrust
him with more restaurants. For example, if the company wanted to sell 3 restaurants
but the person only had the capital for two then the company could sell 2 restaurants to
him using the traditional franchising model and one BFL. The franchisee would then
have the option of converting it to a conventional franchise at some point in the future.
Similarly, the joint venture model is generally used in existing markets who have chosen
to accelerate their growth and who have good candidates with the money for two or
three restaurants but not enough to purchase all the restaurants that the company
would like to sell. The company will then co-invest with the franchisee who will later
have the option of buying out the company's share.
Also, another example of a set of special circumstances is when a restaurant is not very
profitable but there is a clause to the rental contract that states that the company has to
keep operating the restaurant. In a situation such as this one it can be better to use a
BFL than to use internal resources to run the restaurant.
Unsure to be able to renew lease for
restaurant
Business Facility Lease (BFL)
Want to award franchise to franchisee who can’t afford outright purchase
Joint Venture
Business Facility Lease (BFL)
Restaurant not very profitable but have to
keep operating
Business Facility Lease (BFL)
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Analysis of Art4Everyone's Franchising Strategy
The three main factors that lead Art4Everyone to choose company ownership instead of
franchisee ownership are the knowledge of the market (and market risk), desired
proportion of company-owned outlets, and availability of personnel and capital.
Factors that Lead Outlets to Become Company-Owned
The company's knowledge of the market and market risk is one of the main factors
that could lead to company ownership of an outlet. Having knowledge of the market
gives Art4Everyone a better idea of the market risk. Seeing as the company is still in the
early stages, any error could have a dire impact on the company's financial position.
While the company prefers owning stores to selling franchises in markets where there is
a low amount of risk, it is difficult to know how much risk there is in a given market
without actually having stores there. The error margin is razor thin for a new company
with little capital so every company-owned outlet that it opens has to be a success. If
the company doesn't have a solid knowledge of the market and isn't certain that a store
in that market would be profitable then the company can't currently afford to take that
risk. On the other hand, knowing that the store is going to be profitable could lead to
the company building and owning the store, assuming other conditions are met.
The second condition that must be met is that opening a company-owned store has to
fit in the company's objective in terms of proportion of company-owned
restaurants. The company's current objective is to franchise about half of its outlets
and own the other half. According to the person in charge of the franchising in North
America for Art4Everyone, company-owned stores are generally more profitable than
franchises in this industry, which explains why the company's objective is to own at least
half (50%) of the outlets. It's important for the company to have a certain amount of
control over its brand and franchisees in order to maintain its brand image. This
supports Oxenfeldt and Kelly's (1969) idea that one of the things that push the
franchisor towards ownership is the frustration that stems from a lack of control on what
franchisees do. The person in charge of franchising in North America claims that in an
ideal world, every store would be company-owned (giving them perfect control and
greater revenues). This is interesting as it directly contradicts the idea presented in
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theory on the plural form in franchising; that synergies could be derived from a
combination of company-owned and franchised stores (Lewin-Solomons, 2000).
The reason why the objective is 50% is that a higher target is not realistic in the short
term because the company doesn't capital to build stores without support, and it's
important for the company to grow fast in order to prevent other companies from
copying its business model and gaining the brand recognition. Hence, franchising is an
interesting alternative because franchisees bear the financial risk, have experience doing
business in the country, speak the language and have the network. Clearly this is in line
with what was proposed by resource scarcity theory proponents; that people resort to
franchising to overcome limitations to growth (Oxenfeldt and Kelly, 1969).
The second prediction of resource scarcity theory could also apply in this case, as the
company has the option of repurchasing the stores if the objectives that have been set
are not met by the franchisee. The interviewee mentioned that they would be looking at
this option every time a contract was up for renewal, if the objectives hadn't been met.
This is also in line with the resource scarcity theory, which predicted that once
economies of scale had been attained, franchisors would eventually repurchase all but
the least profitable outlets (Oxenfeldt and Kelly, 1969).
Finally, the third condition that must be met is the availability of qualified personnel
and capital. In France, where Art4Everyone has been operating for a few years, there
is now a pool of qualified personnel which could potentially run art galleries therefore
the company does have the option of opening further company-owned stores there.
However, in countries where it doesn't have stores or in countries where it only has
franchised stores, it is quite difficult to open company-owned stores as the company has
no qualified personnel there hence the only option is to open up a franchise. The
company is quite limited in terms of capital seeing as it is just starting up, it does not
have the financial flexibility necessary to open every single store it wants to therefore
choices have to be made. If the personnel and capital necessary to open the store is not
available then the company won't open it, even if the store fits in the company's long-
term plans and even if the company is certain that the store is going to be profitable.
There is a direct link between this factor and what is stated in resource scarcity theory
which is that franchising is used as a way to overcome internal limitations in terms of
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capital and qualified personnel (Oxenfeldt and Kelly, 1969). If these limitations are
present then the company does not have a choice but to franchise the store. On the
other hand, if the limitations are not present then the company has the opportunity to
choose if it wishes to own the outlet or franchise it. Seeing as company-owned stores
are more profitable according to Art4Everyone executives, one could expect the
company to build company-owned outlets in regions with little market risk, where it
knows that the store is going to be profitable. This is linked to the pull-push model
described by Oxenfeldt and Kelly (1969). Essential resources are not always available
early on, but as time progresses they become available which then motivates the
franchisor towards ownership.
Factors that Lead Companies to Choose One Franchising Agreement over the Others
Once Art4Everyone has chosen to franchise, a few factors affect which type of
franchising agreement is going to be used: ownership preference, knowledge of the
market, attributes of the candidate and financial considerations.
Company wishes to build another restaurant
Company will build company-owned outlet if
Market Knowledge and Market Risk: Company knows
that the store would be profitable; there is little to no
risk
Proportion of outlets that should be company-owned is
greater than current proportion
Availability of Qualified Personnel and Capital: The
company has access to qualified personnel and
sufficient capital
Company will build franchised outlet if
Market Knowledge and Market Risk: Company is not certain that the store would be profitable; there is some
risk
Proportion of outlets that should be company-owned is
smaller than current proportion
Availability of Qualified Personnel and Capital: The
company does not have sufficient capital or access to
qualified personnel
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First, the company's ownership preference is one of the main factors that could lead
the company to favor certain franchising agreements. It was stated by one of the
interviewees that the company prefers selling master franchises instead of junior
franchises because master franchises are more independent and require less support.
The fact that Art4Everyone's organization is still fairly small and does not have much
supervisory personnel makes it difficult to supervise a large number of individual
franchisees located in many countries. Hence, it's much easier from a performance
management standpoint to support a few master franchises rather than several junior
franchises. Plus, agency theorist proponents would argue that junior franchisees have an
incentive to "free ride" on the franchisor's brand-building efforts when they do not have
other outlets because they receive all of the benefits of cost cutting but share the cost
of having dissatisfied customers with other outlets (Caves and Murphy, 1976). By giving
out master franchises, the likelihood of franchisees free riding can be reduced because
every store in a region is owned by the same person therefore they receive most of the
cost of having dissatisfied customers.
Another factor that can have a strong incidence on the type of franchising agreement
that is going to be used is the company's knowledge of the market. The company
does not want to undervalue the worth of a master franchise in a particular market. If
the company knows a lot about the market then there is less of a risk of the company
undervaluing the worth of a master franchise in a particular market. In cases where the
company has a difficult time valuing the market's potential, the company generally
prefers selling a few junior franchises. Once those junior franchises are built, the
company can then see how the sales compare to sales in other regions. The company
can then ensure to set a fair price to the master franchise.
Another factor that has a strong incidence on the type of franchising agreement that is
going to be used is the attributes of the candidate. If the candidate who initially
contacts the company only has the capital for (and interest in) opening a single store
then the company will not even consider selling him a master franchise. On the other
hand, if he shows interest in opening a large number of stores and he has the financial
capabilities necessary to open enough stores within a given time period then the
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company will look into attributing him a master franchise (assuming that it is able to
evaluate the fair market value of the master franchise).
Finally, the fourth factor that affects the type of agreement used is financial
considerations. For example, if the right partner comes along and is willing to put up a
lot of money to have a stake in a store in a good market then it could be interesting to
set up a joint venture with that partner as Art4Everyone would get a good value for the
store.
The following graph summarizes the various options that the company considers and the
conditions that must be met for the company to use one type of franchise agreement
over the others.
Conclusion
As a starting point, I conducted a literature study covering the three main theories
related to the antecedents of franchising: agency theory, resource scarcity theory and
Company has chosen to franchise the
restaurant
Master Franchise if
Market knowledge: Company is able to assess
the value of the master franchise.
Attributes of the Applicant: He has the
capital, skill and will to own a master franchise
Junior Franchise if
Market knowledge: Company not able to assess
the value of the master franchise.
Ownership Preference: Sell Master Franchise
later once value can be assessed, if candidate is
willing and able
Attributes of the Applicant: He lacks the
capital, skill and will to own a master franchise
Joint Venture if
Financial Considerations: Potential partner wishes to
own a store in a good market and is willing to put
up a large sum of money
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the plural form in franchising. I found that while a lot of research has taken place on the
antecedents of franchising, there was a clear need for further research on certain topics
related to the antecedents of franchising, namely the types of franchising agreements
that exist and the factors that lead to the use of one over the others. This led to the
following research question:
What factors are taken into consideration by companies in their choice of an
outlet's organizational form?
In order to answer the above research question, a multiply case study was conducted
with a mature, large company in the quick service industry (FoodChain) and a small
company in the art industry (Art4Everyone). The information about the franchising
agreements that these companies use and about the factors that affect the choice of a
franchising agreement over another was collected through interviews and a review of
internal documentation.
The conclusion will be divided in three segments. First I will answer the research
question. Then, I will discuss the limitations, generalizability and managerial implications
of this study. Finally, I will give suggestions on future research related to my findings.
Answer to The Research Question
In this section, I will first start by documenting my conclusions when it comes to the
types of franchising agreements that are used by companies. Then, I will summarize my
findings when it comes to what factors affect the type of franchising agreement used by
companies.
Franchising Agreements Used by Companies
Before identifying the factors that affect the choice of a franchising agreement, I wanted
to get a better understanding of the types of franchising agreements that were used by
companies. I needed to have a good understanding of the types of franchising
agreements that they were using to understand what leads these companies to choose
one over the others.
When it comes to the various types of franchising agreements that were used by
companies, I found that there were discrepancies between the types of franchising
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agreements that are commonly mentioned in research and what companies used in
reality. The four types of franchising agreements that are the most commonly
mentioned in research and by franchising associations are single-unit franchising, multi-
unit franchising, development licenses and master franchises. The conclusions that I can
draw from the interviews I conducted with employees of the two companies are as
follows. First, the two companies did not make a difference between single-unit and
multi-unit franchising, neither did they make a difference between development licenses
and master franchises. Also, both companies used types of franchising agreements other
than the four mentioned above: FoodChain used Business Franchise Licenses (BFL's)
and Joint Ventures while Art4Everyone used Joint Ventures. The aspect that BFL's and
Joint Ventures have in common is that these two franchise agreements both involve a
certain amount of money coming from the company instead of the outlet being solely
funded by the franchisee.
The main conclusion that I draw regarding the franchising agreements used by
companies is that the current franchising literature has mostly considered the size (one
or more franchises) and rights (exclusive territory, right to grant franchises) associated
with franchising agreements. In reality, however, another variable seems to be used:
the financing behind the franchise and whether part or all of it would be financed by the
company.
Factors that Affect the Franchising Agreement Used
Through the interviews with FoodChain and Art4Everyone executives, I identified several
factors that affect the type of organizational form used by these companies. The
following factors were identified in interviews with both Art4Everyone and FoodChain
executives:
Growth anticipated by the company
Proportion of outlets that should be franchised
Financial considerations
Ownership preference
Availability of qualified personnel
Availability of capital
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The following factors were identified solely in interviews with FoodChain executives:
Portfolio optimization
Special circumstances
Expected franchisee turnover
The following factors were identified solely in interviews with Art4Everyone executives:
Market knowledge and market risk
Comparing my findings with findings of earlier literature on the choice of a franchising
agreement, there are clear links to be made. The comparison is not perfectly straight
forward as previous research used different terms to describe similar aspects but I
believe that looking beyond the name and into characteristics of the factors described in
earlier research allows us to identify points of congruence. Earlier research identified
franchisor's financial resources scarcity which is clearly linked to two factors I identified
in my study: financial considerations and availability of capital. Additionally, academics
also identified monitoring costs as a factor, which can be linked to ownership preference
(the difficulty of monitoring many individual franchisees was brought up by several
Art4Everyone executives). That being said, it's difficult to draw conclusions about
discrepancies between this study and previous research because the theoretical
perspectives used to study this phenomenon in the past are largely different from those
used in this study.
There are three main conclusions that I draw from this thesis regarding the factors that
affect the type of franchising agreement used. First, it seems that both companies'
decisions were affected by many of the same factors, even though they were of
different sizes, in different stages of the business cycle and in widely different industries.
The theories that seek to explain the antecedents to franchising (agency theory,
resource scarcity theory and plural form in franchising) seemed to apply to both types of
companies. In fact, there were clear links between these theories and the factors that
were mentioned. For example, financial considerations and the availability of capital had
a considerable impact on whether an outlet would be company-owned or franchised.
These factors also had a substantial impact on the type of franchising agreement that
would be used. Looking at the applicability of the three different theoretical perspectives
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used in the study, I believe that I made the right choice to focus on resource scarcity
theory and agency theory and only use the plural form as a support. The plural form
added the least value as the only moment it had an impact on the two companies
decisions was when it came time to choose between only having franchised stores or
keeping a certain proportion of company-owned stores. Even then, the findings were
mixed as Art4Everyone executives actually stated that "in a ideal world, every outlet
would be company owned".
Second, is that while some factors were common to both companies, there were also
factors that were exclusive to one or the other. For example, the expected level of
franchisee turnover and portfolio optimization were only factors for FoodChain, while
market knowledge was only a factor for Art4Everyone. One could wonder if this
difference is caused by the stage of the business cycle and the different situations in
which these companies find themselves. As a mature company with outlets in more than
100 countries around the world, FoodChain already has a fairly good market knowledge
of most countries and regions of the world therefore the fact that this factor is not really
considered by the company should not come as a surprise. On the other hand, expected
turnover and portfolio optimization are not factors that Art4Everyone considers because
the company is still in its infancy. There has not been any franchisee turnover yet,
people are bound by contracts, the company's portfolio is still in the process of being
built and there are still plenty of good locations where the company can build. It makes
more sense for the company to keep expanding than to start repurchasing franchises
right away as that would slow the company's expansion. I can't draw definitive
conclusions on this matter but I believe that this is a topic which is definitely worth
researching further. My hypothesis, which is clearly supported by the above arguments,
is that the factors that companies consider may be partly related to the stage at which
the company is in the business cycle. I believe that a link could be made between this
hypothesis and the life-cycle model in the resource scarcity theory as the main idea
behind the life-cycle model is that a franchisor and a franchisee's goals, opportunities
and capabilities maybe change over time and lead them to want different things than
they may have wanted earlier in the existence.
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The third and final conclusion that I draw is that some franchising agreements were
specifically created to deal with special circumstances. For example, Business Franchise
Licenses (BFL's) emerged because FoodChain absolutely wanted to grant franchises to
talented franchisees even if they couldn't afford them completely, instead of lowering
their standards for the personnel and granting the franchises to applicants that weren't
as talented. Hence, the companies found innovative ways to grant franchises to the
right people by looking at aspects beyond what was typically considered (size and
rights).
Limitations, Generalizability and Managerial Implications
Unfortunately, case studies have limitations. Hodkinson (2001) found certain limitations
to case studies to which this particular case study does not escape. First and foremost,
case studies are not generalizable in the conventional sense. The sample is small and
idiosyncratic, and the data is predominantly non-numerical which means that there is no
way to establish the probability that the data is representative of some larger
population. Another limitation is that there is so much data that it difficult to cover
everything to the same extent, some information has to be omitted or at the very least
summarized. Linked to this limitation is the fact that the complexity examined is difficult
to represent simply. It's difficult to present pictures of the complexities of social
situations in writing because writing is predominantly a linear form of communication
but what case studies reveal is not like that. By writing about one aspect of an issue,
other issues are often unintentionally concealed (Hodkinson, 2001).
As for the generalizability of case studies, Hodkinson (2001) believes that even though
case studies cannot be representative and findings can't really be generalized, the
information found in case studies can often tell us about situations beyond the actual
case that was studied. He argues that "case studies can provide provisional truths, in a
Popperian sense", that the best theory thus far should stand until contradictory findings
or better theorizing has been developed. Following this thinking, the findings from this
case study should be seen as a provisional truth until better theorizing has been
developed. While the findings are not generalizable per say to other companies and
industries, I believe that they are well supported by evidence and arguments. As long as
the reader understands the strengths and limitations of the methods and approaches
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used, I believe that the findings can add value beyond giving information on the case
that was studied and that there are aspects of the thesis that can serve companies in
the future. For example, this study found that the two companies used franchising
agreements that were sometimes different from those most often mentioned. It may not
mean that every company uses heavily customized franchising agreements but it does
mean that some do, and that it may be interesting for others to follow in this path.
In terms of managerial implications, I believe that there are two main implications. First
is that companies should consider adapting franchising agreements to their specific
situation in situations when the better known franchising agreements do not apply. This
research gave franchisors a better idea of the characteristics of the various types of
franchising agreements that are used. Second is that it would make sense to consider
the various factors that were mentioned by the two companies because there is always
a chance that they could apply to the reader's industry or company. Of course, the
factors may not necessarily all apply. Still, this thesis gives academics and owners a
better idea of under what circumstances certain franchising agreements were used by
other companies. This information, which is not publicly available, can be particularly
interesting for companies hoping to learn about other companies' experiences before
elaborating their own process.
Future Research
In this final section of the final chapter, I give suggestions on future research connected
to my findings and raise questions that have been raised by this case study.
Additional Exploratory Research
As I interviewed the executives from the two companies, there are several interesting
questions that arose that I felt could be interesting to look into. For example, I
wondered at the role of that the stage at which a company is in the business cycle plays
on the factors that a company considers when choosing which franchising agreement it
is going to use. While I believe that this should impact the factors that companies
consider when deciding which franchising agreement is going to be used, it is not
something that my interviewees mentioned. My guess is that it was not mentioned
because the companies remained at the same stage over the duration of the study.
After all, if it doesn't change over time then it will not affect their decisions differently,
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meaning that there is no point in paying attention to it. This could potentially be linked
to the life cycle model mentioned in resource scarcity theory.
Additional studies could also try to identify other factors that impact firms' decisions, as
well as other types of franchising agreements that are used by companies. I believe that
a study which identified various types of franchising agreements used by companies and
nuances between them could be interesting for owners as it might give them ideas
which they would not have thought of otherwise. The best known types of franchising
agreements look at the size (one or more franchises) and at the rights (exclusive
territory, right to grant franchises). This study identified a third axis: how the franchise
itself is financed. It could be interesting for a researcher to try to understand what other
variables exist.
Looking at franchising from a slightly different angle, it is simply a partnership between
two parties in which one party provides capital and personnel and the other provides
intangible assets (processes, reputation, customer base, etc.). I believe that one could
try to compare the various types of franchising agreements that exist with the types of
partnerships that are used, because differences when it comes to the types of
partnerships that exists could also potentially apply to franchises. For example, one of
the aspects that is mentioned quite often when it comes to partnerships is liability.
There is a chance that franchisors in certain industries handle liability differently than in
other industries. Perhaps that aspect (or other aspects) could be used to invent new
types of franchising agreements that are better suited to today's reality.
Writing this thesis was very challenging but also an incredibly rewarding experience. I
believe that this thesis managed to enhance knowledge on how firms actually franchise.
That being said, I think that there a lot of research will have to be done before the gap
in research is fully bridged. It is my hope that researchers in the future will build on this
thesis to try and shed more light on the rationale behind the choice of a franchise
agreement.
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